Thursday April 19, 2007 - 04:36:23 GMT
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Black Swan Capital - www.blackswantrading.com
Aussie Teetering Dangerously High
â€˘ U.K. Pound Touches Highest In More than Quarter Century on Bank Minutes â€“ (Bloomberg)
â€˘ Swiss Franc Gains Versus Euro a Second Day as Investors Shun Risky Assets â€“ (Bloomberg)
â€˘ Fannie and Freddie Polish Image With Subprime-Loan Purchases â€“ (WSJ)
â€˘ Key Reports Due (WSJ):
8:30a.m. Initial Jobless Claims For April 14 Week. Previous: +19K.
10:00a.m. March Conf Board Leading Indicators. Previous: -0.5%.
10:00a.m. DJ-BTMU Business Barometer For April 7 Week. Previous: -0.4%.
12:00p.m. April Philadelphia Fed Business Index. Previous: 0.2.
â€śThey who can give up essential liberty to obtain a little temporary safety deserve neither liberty nor safety."
FX Trading â€“ Aussie Teetering Dangerously High
Itâ€™s been a while since anyone had a good feeling about domestic consumption in Japan. And for just as long, interest rates have been held down in hopes of allowing economic growth to sprout up. Thatâ€™s kept the yen depressed and allowed Japanâ€™s export market to flourish.
But what happens if Japanâ€™s exports and Japanâ€™s consumption habits synch?
First of all, it would be quite reassuring if this two-headed economic-growth warrior could exist for more than a month. This way, market watchers couldnâ€™t comfortably dismiss the event as a fluke and resume their current behavior. Should we, however, start to notice a developing trend in all-around positive economic growth -- something Japanâ€™s lacked for many years now â€“ it could really shake up the currency markets. The effects of which would quickly infest other asset markets for sure. The complacency thatâ€™s befallen the markets would really start to bite.
But letâ€™s limit our view to just the currency markets. Carry-trades have no doubt been one of the dominating themes in our analysis of currencies since the year began. This strategy will certainly feel the largest impact should the Bank of Japan adopt a steady monetary policy tightening campaign with hopes of combating inflation and keeping the economy fit.
In fact, two separate reports, one on Tuesday and one yesterday, revealed inflation may be growing faster than expected and consumer demand is surprisingly improving. An official report next week could show that core consumer prices in Japan have risen. Moreover, in February, demand for services rose to a record, far outpacing any estimates set forth by analysts. Additionally, the BOJ will report on interest rates next week [queue Jeopardy music.]
And donâ€™t forget that the Australian dollar, currently yielding a hefty 6.25%, is a huge beneficiary of carry trades â€“ borrowing where the money is cheap, investing where the money is easy.
Yet even if Japan disappoints and rates stay put, we still canâ€™t seem to take our eye off of the Aussie. Itâ€™s at 17-year highs, in nose-bleed territory for sure, and looks very vulnerable to us. And just as some feel about the Australian equity markets, which are putting in record highs, we feel the Australian dollar is radically overextended. We ask ourselves: is there anyone left, not already positioned long-the-Aussie, who can help it maintain its relentless climb? Or are we close to seeing buying interest top out and a correction ensue?
Our money is on the latter. After too long looking down from atop the high-dive one starts to get a little dizzy. A brutal belly-flop could be in the Aussieâ€™s future. But be ready for the cannonball!
John Ross Crooks III
Reader Response to yesterdayâ€™s S&P Index relative valuation to the US$ Index:
â€śTraditionally, the relative valuations of a national currency are set by long-term trade deficits and surpluses: If a country runs a persistent trade deficit, its currency piles up in the external financial system. The resulting oversupply causes the market price of the currency to decline, which causes that countryâ€™s exports to become more competitive and which causes that country to import less and this eventually eliminates the trade deficit. Itâ€™s a very nice theory of trade equilibrium.
â€śAs they say in New York, Fuggetabouddit.
â€śIn the real world, relative values of foreign currencies are set by the market, whose behavior is well-known to be non-rational. In the real world, the US gets to run large, persistent trade deficits forever, because the US dollar is the worldâ€™s reserve currency. Why is the dollar the worldâ€™s reserve currency? Because if you complain about it too much, the US Air Force and the US Navy will blow your skanky ass away. Ask Saddam, or Noriega. I am unaware of any theory of foreign currency valuations which incorporates this particular set of factors.
â€śRight now, trade does not seem to have any effect on relative currency valuations. The primary factor appears to be differential interest rates and the secondary factor is expectations regarding future trends in interest rates. In particular, people are borrowing in yen as fast as they can, selling the yen, and buying Pounds, NZ Dollars, or Aus Dollars. This is the famous â€ścarry tradeâ€ť. What is interesting is the published analysis: Japanâ€™s economy is still weak and the central bank is under considerable political pressure to not raise interest rates. Meanwhile, inflation in the UK has spiked up in the last few weeks, and there is a perceived bias towards increasing the interest rates there, which makes the currency more attractive as a destination for short-term investment. In other words, the supply of yen is coming from sources which have nothing to do with trade, and inflation in the UK is causing the market value of the pound to go up. Go figure.â€ť
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