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Thursday, July 16, 2009
China and the G-8
The origin of the Group of Eight was an invitation from French President Valery Giscard d'Estaing in 1975 to six of the major World War Two combatants to meet at Rambouillet in France. Leaders from West Germany, Great Britain, Italy, the United States, Japan and France attended that first meeting. The impetus to the summit, if not the sole topic, was the first post war economic challenge to the west, the 1973 OPEC oil embargo. In 1976 Canada was invited to join and the group stayed at seven until 1997 when Russia formally became a member.
Although formed a generation after the end of the Second World War, the G-7 represented the dominant nations of the defining event of 20th century history. As with the United Nations for international politics, the G-7 was an attempt to secure the victory of the western economic model. For the first 30 years after the war the only antagonist for the western capitalists had been the political and military threat of the Communists led by the Soviet Union. Until the oil embargo there had not been a serious economic challenge to Western Europe, the United States and Japan.
Why relate this history? The nations of the Second World War consensus that have dominated the world for 60 years are close to bankrupt. Their foreign bankers are now calling the shots; those who pay decide the future.
The abandonment of the climate change issue at the G-8 meeting is an example. Though the global warming agenda is a major part of the domestic political positions of President Obama, Chancellor Merkel, Prime Minister Brown and President Sarkozy the issue was removed from G-8 consideration because China, India and others would not go along. This is perhaps a foretaste of what will happen on every topic in which China and the other BRIC (Brazil, Russia, India, and China) countries have an interest.
China, Russia and India have been very public with their concerns for the long term value of the US Dollar and critical of the effect of American deficit spending. In April, China's holding of US Treasuries fell for the first time in eleven months. The amount was small, $4 billion and partially offset by a small gain in Hong Kong. But in the charged atmosphere of today's international economics and in light of US funding needs, the drop was widely noted. From April 2008 until March 2009 the Chinese Government had been steadily acquiring Treasuries; its holding had increased from $502.0 to $767.9, a jump of 53%.
China has also moved to increase the supply and demand for the yuan as an alternative to the dollar by starting limited trade settlement in its currency. On July 6th some firms in five Chinese cities were allowed to begin settling transactions in yuan with companies from Hong Kong, Macau and the ASEAN countries. Non-Chinese banks will be able to obtain yuan from mainland institutions to finance trade.
The Peoples Bank of China (PBOC) has also formulated currency swap agreements with Argentina, Belarus, Hong Kong, Indonesia, Malaysia and South Korea. The PBOC will render yuan to their central banks as needed to pay for imports if these countries are short of the currency.
These moves by the Chinese authorities will not establish the yuan as an international reserve currency. But they will shift some of the trade demand for dollars to yuan. Offered the choice what Asian trading partner of China would not want to remove the volatile and increasingly questioned dollar from their financial equation? The logic is simple and efficient. Why hold reserves in dollars for your China trade and bear the currency risk? Yuan reserves reduce the need for dollars and reduce dollar currency risk.
China has emerged as the engine of growth in Asia and Asian countries are looking to China for the health of their own economies. If yuan settlement becomes the policy of the Chinese Government what trading partner will want to go against Beijing's wishes and opt for dollar settlement? Considering the size of China's foreign trade the potential drop in dollar demand could be substantial.
Until now it has been in China's interest to keep the yuan undervalued for trade competition. Since last summer China has effectively re-pegged the yuan to the dollar after three years of gradual appreciation. But that is likely to be a temporary expedient. If China is serious about using the yuan in trade and in permitting outside players, non Chinese players, to hold and store value in yuan, an essential component of a reserve currency, what better way than to resume a gradual appreciation of the currency? For an exporter in Vietnam or Thailand or even Australia, Japan or New Zealand would not an appreciating yuan be a far better option for your China trade capital than the dollar?
Chinese national interest will determine Beijing's economic policy. But the time is fast approaching when safeguarding her economic development will be far better served by a strong and convertible currency than by a weak yuan priced for export. A strong dollar has been one of Washington's most effective foreign policy tools for more than 50 years; that fact is not unknown in the Chinese capital.
Joseph Trevisani
FX Solutions, LLC
Chief Market Analyst
Monday, July 13, 2009
Sunday, July 12, 2009
Treasury Rates and the Dollar
In a normal world these two charts would be complementary. As interest rates on the 10-year Treasuries rise one could reasonably expect the Dollar Index to follow. But ever since March18th when the Federal Reserve announced its $300 billion quantitative easing policy, the divergence has been pronounced.-the higher Treasury rates climb the lower the Dollar Index sinks. Has the natural order of the currency markets been upended?
| 10 Yr Treasury Yield 1 year chart | Dollar Index 1 year chart |
In normal economic times the currency market and the bond market respond to the anticipation of higher US rates. The price of Treasuries fall, the yield climbs and the dollar gains. It is the expectation of returning economic growth and inflation that piques the anticipation for a new upward rate cycle from the central bank. If this were a standard recession, with three quarters of negative growth already past, historically low rates, large amounts of additional liquidity, and the first stirrings of recovery, market anticipation would focus on the changeover to a restrictive rate policy.
But these are not normal times. Fed rate policy is constrained by the recession and the residue of the financial crisis. The Fed cannot and will not raise rates until the economy is clear of the threat of deflation and the financial system has restored its ability to lend and supply credit to the economy.
The Fed is in a bind. If it lets consumer interest rates rise it undermines the economic recovery its policy has been trying to foster since last year and risks choking off whatever economic stabilization has been achieved. But if it increases its purchases of Treasury debt to keep rates low then it provokes fears of future inflation; and, what is perhaps more damaging, the suspicion that the US government is willing to monetize its debt.
In the current economic environment, and especially in light of the government's unprecedented funding needs, extensive Fed purchase of government notes, quantitative easing, will cause as much harm as good. 'Quantitative easing' is simply a different term for the monetization of government debt. The Federal Reserve buys debt issued by the Treasury and the Treasury uses the proceeds of the sales to pays its bills, which means distributing the new dollars to the economy.
The inflationary result of quantitative easing is twofold. It contributes directly to present inflation by increasing the money supply and by devaluing the dollar, raising the cost of dollar priced commodities like crude oil. Higher oil prices feed back into consumer price inflation. Last summer's $4.00 a gallon gasoline was at least partly caused by the historically weak dollar. The cost of gasoline acts as a direct drag on consumer spending, reducing disposable income. The pump price for a gallon has gained more than the dollar in the past two months.
The second effect of quantitative easing is more insidious but in the long run far more damaging to the US dollar. If higher rates for US Treasuries indicate an oversupply of these dollar assets then they pose a danger to the dollar's status as the world's reserve currency. One of the basic functions of a reserve currency is as a store of value for liquid assets. If investors look into the future and see only an ever increasing supply of dollar assets for sale, in numbers far beyond the rate of economic growth in the US, issued by Washington to fund its deficits, then the value of those assets will likely to fall..
The financial crisis was a singular event and it prompted an unprecedented flight to quality in the Treasury market. The demand for security was so great that Treasury yields fell far below historical analogues. Two developments particular to the Treasury market and abnormal in the sense of never having occurred before have kept the currency markets from responding in a standard fashion to the rise in Treasury rates.
First, the recent increase in the 10-year yield has taken place in the contest of historically low Treasury rates. The 2.03% yield of last December was an anomaly and the return to more normal yields should not be taken to mean anything but that the most extreme portion of the financial crisis is passed. Higher Treasury yields do not in this case mean a change in Fed policy is near.
| 10 Year Treasury Yield 20 Year Chart |
The second Treasury market development is also brand new and without historical example: the budget plans of the Obama administration.
The Democratic administration isn't just issuing record debt this year. For the next ten years, in the government's own projections, deficits never drop below $500 billion in any year. The administration claims that this scale of debt is necessary to help the US avoid the worst effects of the recession. But the costs of the array of new programs that are part of the budget projections dwarf anything that the US government has ever enacted before. Every dollar of this new spending will have to be borrowed.
For the Treasury market the vast supply of issuance threatens to overwhelm demand. This quantity of government debt has never been put for auction to the world's investors. Their response is unknown. Will the United States government be able to sell its debt and fund its deficit? Yes. The question is at what cost. How much higher will returns have to go to keep buyers purchasing US securities?
In pushing Treasury rates higher, the bond market is responding to the enormous pending supply of government debt and to the historic lows in Treasury yields that resulted from the financial panic. 3.7% yields in the 10-year Treasury are not indicative of a Fed on the verge of a restrictive interest rate policy. .
Because both developments were singular to the Treasury market and do not yet represent a scenario dangerous for the US economy the currency market response was muted. It remains to be seen if currency traders view the projected massive increase in American debt as a positive or negative for the dollar.
Joseph Trevisani
Chief Market Analyst Joe@fxsol.com
The FOMC, Quantitative Easing and the Dollar
The currency market view of quantitative easing
Monetization or a stable dollar
The normalization of Treasury rates
A foreign veto on quantitative easing?
After a few months out of the currency spotlight the Federal Reserve will once again be the focus for traders when the Federal Reserve Open Market Committee (FOMC) meets this coming Tuesday and Wednesday. This time it will not be the Fed Funds target rate, the central bank's chief historical policy tool, that will be the locus of interest but the several special programs that the Fed has used to stem the financial crisis, in particular the quantitative easing attempt to cap Treasury interest rates.
Various Fed disbursements have added more than one trillion dollars in liquidity to the United States financial system. With up to $3.25 trillion in Federal debt sold or slated to be sold in the credit markets before the end of the US fiscal year in September oversupply and inflation are serious potential concerns that could drive Treasury interest rates considerably higher.
The 10-year Treasury note has risen more than 1.6% in yield since March and the reason for this sharp increase has gotten much speculative coverage in the press. But in fact the yields on the 10-year note have simply returned to where they were before the financial collapse last fall. Treasury yields have been trending downward for more than twenty years. It was the dip to zero yields in the wake of the Lehman failure that was the singular event not the recent return to trend. That is not to say that the huge coming supply of Treasuries and the theoretical inflation potential of the projected Federal deficits could not drive Treasury rates much higher. But the Friday close of the 10-year Treasury at 3.78% is a likely starting point for an inflation fueled run higher in yields, not an indication that it has already begun.
The currency market reaction to the Federal Reserve quantitative easing policy was as negative for the dollar as the policy itself was ineffective. If the goal of the policy were to put a floor under Treasury prices it failed. If its purpose was to indicate a serious Fed concern for consumer interest rates and hope that the bond market would take the hint it was also a failure. The quantitative easing purchase amount of $300 billion was always far too small to prevent a fall in Treasury prices if market sentiment were negative.
Quantitative easing has been detrimental to the dollar for three reasons. First and most important it monetizes US debt. With trillions of dollars more of US debt yet to be sold this year alone any hint that the US will print dollars to pay for its own debentures is anathema to currency traders and to holders of US debt. The fact that the policy was a failure, Treasury rates rose despite the Fed purchases, was unimportant. It was the potential flood of new dollars that impressed the currency markets. Second, if the US economy could not tolerate a return to more normal Treasury rates from the abnormal levels of March when the 10-year note was in the low 2.00s% then what possibility was there for an economic recovery anytime soon? And finally if the Fed were willing to take the momentous step of buying Treasury issues to keep interest rates from rising then any speculation that the Fed might begin raising rates sooner than expected was misplaced.
When the Fed announced its quantitative policy in March 18th the governors were in reality utilizing their other traditional economic policy tool--Talk. Given the small amount of the announced purchases and the six months time frame the Fed must have hoped that the mere existence of this exceptional precedent would hold the Treasury market much as intervention can sometimes deter the currency markets. The governors must have known that $300 billion would never thwart a determined bond market.
Mr. Bernanke also chose to use this traditional central banker's tool to limit the effect of the quantitative easing policy. In testimony before Congress on June 3rd he said that 'deficits cannot continue forever'. It is of course a truism, but it is a truism with a point. The Fed does not control the deficit and rarely makes comment on fiscal policy. But it does control the Fed purchases of Treasuries. The goal of the easing policy was to bolster the consumer economy by keeping mortgage and other consumer rates from rising to levels where they inhibit consumption. Was this criticism of the administration's deficits an indication that the Fed now views the easing policy as a failure? If that is the case then the link between the deficits and quantitative easing is the dollar.
Nothing will be more damaging to the Obama administration's deficit funding plans than a collapsing dollar. The mere hint of such a run on the dollar brought heavy and unusual criticism from the Chinese and the Russians; and their warnings are not empty. If the currency markets drive down the dollar because traders fear monetization there will be little that owners of US debt can do with their current inventory, selling would only worsen the run. But China and Russia do not have to buy more Treasuries; and the administration must sell Treasuries or abandon its domestic agenda. A substantially lower dollar could also bring crude oil prices to $100 a barrel and beyond. One of the contributing factors to the plunge in consumer spending in the US and elsewhere was the rapid rise in gasoline prices.
The Fed cannot do two things at once. It cannot keep US consumer rates from rising with a renewed and augmented quantitative purchase program and hope to maintain a stable dollar. The currency markets have made their view of quantitative easing quite clear. Even though US interest rates rose from March the dollar fell. Monetization is a greater threat to the dollar than rates are a support.
The Fed governors must decide which is more important: domestic interest rates or a stable dollar. The FOMC approach to quantitative easing will provide the answer. This is an important meeting.
Joseph Trevisani
Chief Market Analyst Joe@fxsol.com
Market Directions July 06, 2009
The Psychological Utility of Technical Analysis
Joseph Trevisani
Chief Market Analyst
FX Solutions
The Psychological Utility of Technical Analysis
Technical analysis is sometimes studied as if it contains a grain of secret knowledge or portrays an intrinsic truth about currency movements. Often it is said that a specific chart formation will produce a specific price movement.
Technical analysis does nothing of the sort. A chart is a reflection of past prices, nothing more. In itself a graph cannot predict future price movements. A currency does not trade up of down because of a formation on a chart. It moves because market participants make basic assumptions about future price behavior based on the record of past price action. A charted history of price action is the cumulative story of thousands of trading decisions; it is a record of the past behavior of thousands of individual traders.
Price information is meaningful only because trader’s decisions give it predictive power. A simple proof of the limited forward intelligence of historical price action is the well attested notion that fundamental developments always trump technical analysis. If the Federal Reserve raises rates unexpectedly or the Chinese Government announces it will no longer buy US Treasuries there is no chart formation that has ever existed that will prevent the dollar from rocketing up in the first instance or plummeting in the second.
Technical analysis does not produce price movement. I state the obvious because in the endless attribution of trading cause and effect to ‘the market’ it is easy to lose sight of the actual composition of the market--thousands of individual decision makers. The translation mechanism for technical analysis runs from the information contained in a chart, through the assessment of that information by market participants to the trading behavior of those market participants.
Another way to approach this idea is to ask, just who is the ‘market’ and what is it trying to accomplish every day. It is likely that over 90% of the $3.2 trillion daily volume in the FX market is speculative. That means that everyone in the market from the hedge fund trader with $1 billion under management, to the euro trader on the Deutsche Bank interbank desk to the retail trader in her study, is trying to do exactly the same thing, take home daily trading profits.
Interestingly, the overall worldwide foreign exchange trading volume in 2007, the year of the last survey, increased almost 50% from the prior survey in 2004 of $1.9 trillion daily. The counterparty reporting segment to which retail foreign exchange belongs boosted its share of turnover to 40% from 33% according to Bank for International Settlements in Basel (BIS, 2007) which conducts the tri-annual survey.
To return to my previous point, if every market participant is attempting to do the same thing, namely wring trading profits from the day’s activities, how do they all go about it?
The first thing every trader does, in New York, Tokyo, London and in every land in between is to pull up charts and look for trading opportunities. Every trader looking for profit is judging the same charts. Everyone sees the same price history, and everyone identifies the same potentially profitable chart formations. And, in the absence of other factors, the majority of traders will come to the same trading conclusion based on the observed chart formations.
If euro has been in an up channel for two weeks and is approaching the bottom of the channel most traders looking for an opportunity in euro will bet on the continuance of the up trend and the maintenance of the channel. They will place buy orders just above the floor of the channel. And much of the time the charts will have been proven correct, the euro will indeed bounce from the floor of the channel. But it bounces not because, for instance, the ECB is expected to raise rates at some future date, but because of the fit between the goals, information and assumptions of the market’s traders.
Traders need profits, all charts contain the same information and all traders operate with similar assumptions about market behavior based on chart formations. If enough traders place their buy orders above the bottom of the channel it becomes likely that the euro will bounce off the floor of the channel and continue the upward channel formation, barring external events of course.
There is powerful self-fulfilling logic in technical analysis, it works, because everyone trading believes it will work and makes their trading decisions accordingly. For a retail trader this knowledge is the most accessible and effective trading strategy that exists.
Joseph Trevisani
FX Solutions, LLC
Chief Market Analyst Joe@fxsol.com
Market Directions July 06, 2009
The Psychological Utility of Technical Analysis
Joseph Trevisani
Chief Market Analyst
FX Solutions
The Psychological Utility of Technical Analysis
Technical analysis is sometimes studied as if it contains a grain of secret knowledge or portrays an intrinsic truth about currency movements. Often it is said that a specific chart formation will produce a specific price movement.
Technical analysis does nothing of the sort. A chart is a reflection of past prices, nothing more. In itself a graph cannot predict future price movements. A currency does not trade up of down because of a formation on a chart. It moves because market participants make basic assumptions about future price behavior based on the record of past price action. A charted history of price action is the cumulative story of thousands of trading decisions; it is a record of the past behavior of thousands of individual traders.
Price information is meaningful only because trader’s decisions give it predictive power. A simple proof of the limited forward intelligence of historical price action is the well attested notion that fundamental developments always trump technical analysis. If the Federal Reserve raises rates unexpectedly or the Chinese Government announces it will no longer buy US Treasuries there is no chart formation that has ever existed that will prevent the dollar from rocketing up in the first instance or plummeting in the second.
Technical analysis does not produce price movement. I state the obvious because in the endless attribution of trading cause and effect to ‘the market’ it is easy to lose sight of the actual composition of the market--thousands of individual decision makers. The translation mechanism for technical analysis runs from the information contained in a chart, through the assessment of that information by market participants to the trading behavior of those market participants.
Another way to approach this idea is to ask, just who is the ‘market’ and what is it trying to accomplish every day. It is likely that over 90% of the $3.2 trillion daily volume in the FX market is speculative. That means that everyone in the market from the hedge fund trader with $1 billion under management, to the euro trader on the Deutsche Bank interbank desk to the retail trader in her study, is trying to do exactly the same thing, take home daily trading profits.
Interestingly, the overall worldwide foreign exchange trading volume in 2007, the year of the last survey, increased almost 50% from the prior survey in 2004 of $1.9 trillion daily. The counterparty reporting segment to which retail foreign exchange belongs boosted its share of turnover to 40% from 33% according to Bank for International Settlements in Basel (BIS, 2007) which conducts the tri-annual survey.
To return to my previous point, if every market participant is attempting to do the same thing, namely wring trading profits from the day’s activities, how do they all go about it?
The first thing every trader does, in New York, Tokyo, London and in every land in between is to pull up charts and look for trading opportunities. Every trader looking for profit is judging the same charts. Everyone sees the same price history, and everyone identifies the same potentially profitable chart formations. And, in the absence of other factors, the majority of traders will come to the same trading conclusion based on the observed chart formations.
If euro has been in an up channel for two weeks and is approaching the bottom of the channel most traders looking for an opportunity in euro will bet on the continuance of the up trend and the maintenance of the channel. They will place buy orders just above the floor of the channel. And much of the time the charts will have been proven correct, the euro will indeed bounce from the floor of the channel. But it bounces not because, for instance, the ECB is expected to raise rates at some future date, but because of the fit between the goals, information and assumptions of the market’s traders.
Traders need profits, all charts contain the same information and all traders operate with similar assumptions about market behavior based on chart formations. If enough traders place their buy orders above the bottom of the channel it becomes likely that the euro will bounce off the floor of the channel and continue the upward channel formation, barring external events of course.
There is powerful self-fulfilling logic in technical analysis, it works, because everyone trading believes it will work and makes their trading decisions accordingly. For a retail trader this knowledge is the most accessible and effective trading strategy that exists.
Joseph Trevisani
FX Solutions, LLC
Chief Market Analyst Joe@fxsol.com
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