Currency Story Continued

From Reuters:

MORE TO COME?
The Singapore dollar, widely used with the yen to bet on a yuan move, shot higher to a two-month high of 1.6503 per U.S. dollar, up 2 percent on the day compared with 1.6843 on Wednesday, before dealers reported the intervention.
Singapore said it will maintain its policy of gradual and modest strengthening of the Singapre dollar and said fundamentals of the city-state's economy had not changed.
Hong Kong said it would not consider changing its currency peg to the dollar even if the yuan keep appreciating and said the Hong Kong dollar will remain very stable.
The Indian rupee rose to a six-year peak against the dollar around 43.20, up more than half a percent.
"The move is clearly positive for Asian currencies first, and to some extent the euro. It is pretty clear that the basket will involve a reasonable chunk of Asian currencies," said Emanuele Ravano, European strategist at PIMCO in London.
The Korean won's non-deliverable forward prices, used by offshore investors to trade the won, showed investors are factoring in a 2.2 percent rise in the won/dollar rate in one-month's time.
...

Following the yen's rise of more than two percent, Japan's top financial diplomat Hiroshi Watanabe said he is watching the market carefully and would take action if needed.
Japan has been urging China to reform the rigid FX regime but it had repeatedly said the yuan revaluation doesn't mean a higher yen and it has hinted it would intervene if necessar

Update 2:51 PM: This quote from Nouriel Roubini sums up what I am watching for:

And this could really be the beginning of the end of the Bretton Woods 2 regime of fixed pegs to the U.S. dollar in Asia. Malaysia already decided today to drop its peg relative to the U.S. dollar. This China move may also force Hong Kong to phase out its long term currency board and U.S. dollar peg. And other Asian currencies will soon sharply appreciate, following the yen's lead today. Even currencies at the periphery of this Bretton Woods regime (such as those in Latin America) may sharply appreciate. The systemic consequences of this currency realignment throughout Asia and the world could be radical and have significant impacts on U.S. long-term interest rates, on U.S. financial markets and on the U.S housing bubble.

Yen Strength

From Bloomberg:

The yen rose the most in seven weeks against the dollar and appreciated against all major currencies on speculation China is closer to a decision to allow its currency to trade more freely.
The rise in the yen followed an announcement that U.S. Treasury Secretary John Snow and Federal Reserve Chairman Alan Greenspan will testify to Congress on June 23 about U.S.-Chinese economic relations. Both men have called for China to let the yuan float, freeing it to appreciate against the dollar. A stronger yuan boosts the yen by improving Japan's export competitiveness against China.
``The revaluation news spread like wildfire,'' said Enrico Caruso, chief trader at currency hedge fund Tempest Asset Management in Newport, California. ``That's the biggest driver of the dollar-yen right now.''
...
The latest round of speculation that the yuan would be revalued was tied to the announcement earlier today that Chinese President Hu Jintao will attend the Group of Eight industrialized countries' annual summit in the U.K. on July 7, according to Patrick Brodie, chief currency dealer in New York at Sumitomo Mitsui Banking Corp.

I am pretty sure this is a case of trying to fit the news to the market. Not that I disagree with the move but I don't think the G8 attendence in itself means anything. I mentioned last week that sentiment had swung about as far as I thought possible from the "its coming tonight" view of two months back.

China's Peg Planning

From the NYT:

China's political leadership is actively considering breaking the 11-year link between the dollar and China's currency, the yuan, and tying its value instead to a group of currencies, current and former senior Chinese officials said in interviews. The proposal being weighed at almost daily meetings of the Standing Committee of the Chinese Communist Party's Politburo would use a so-called basket of currencies to set the yuan's value. The yuan would move up and down in currency markets in relation to the average values of the dollar, yen, euro and possibly other currencies like the British pound.

But the initial value of the yuan under the new system could, in dollar terms, be very close to its current value of 8.277 to the dollar.
...
The Politburo's Standing Committee - which includes President Hu Jintao, Prime Minister Wen Jiabao and seven other top officials - has made no decision yet on when or whether to act, and may decide soon or wait as long as next year, the officials said. But the deliberations have taken on a pressing quality, with the Standing Committee meeting almost every day last week to review currency policy. Senior economic officials have been told to be on hand for consultations at any moment.
In a telling instance, Yang Weizhe, the mother of Zhou Xiaochuan, the governor of the Chinese central bank, died at 6:30 a.m. on May 31, but Mr. Zhou was still required to attend a Standing Committee meeting on the currency an hour and a half later.

...

Victor Fung, a Hong Kong tycoon who is chairman of one of the world's largest garment companies and heads the territory's airport authority, said, "They recognize the need to go away from a peg and move toward a basket."
Mr. Fung said each currency's percentage in the basket should match the percentage of China's trade conducted in that currency, an approach favored by many economists. He also said that China should reveal the relative weightings of the currencies in the basket.
But other advisers said Chinese officials were leaning strongly toward switching to a basket without disclosing the currency weightings. Singapore has long done this with its dollar.

A few weeks ago speculative pressures were the reason for not moving. The current sentiment (knowing it is coming but it will be small and hard to time) is probably the best Chinese politicians can hope for.

They sure seem to be focusing on the finer details right now. In currencies I have quite a few yen longs on and most recently shorted AUD/JPY near here (stop at 83.5). That chart is bouncing along just on top of a long uptrend and looks set to have a big reaction to any yen strength. Other than oil, the commodity stocks have not put in much of a recovery so I am also watching the AUD to see if it is pointing out continued weakness there.

Corporate Spreads Still a Problem

From the FT:

The supply of new European corporate bond issues more than halved in May compared with the same period last year as borrowers were pushed to the sidelines amid the sharp volatility in the secondary market.
The supply of new bonds with investment-grade credit ratings reached just EUR6.875bn in May, down 52.5 per cent from the same month in 2004. The supply in the year to date is running 26 per cent below last year's levels, which ended up being 40 per cent weaker than 2003.
But the reason behind the low issuance in May and late April differed from that of the preceding months, in that it was the market that turned away from borrowers and not the other way round.

The article continues by discussing the return of investor demand in later May. Even so I think the trend of spread widening that started in March has a ways to go. Because of that I am leaning towards shorting stocks here but am patient to see where this rally goes. Seems like we could hang out around these levels for a few weeks.

Of course I am still watching TOL as a main tell. It seems like sentiment could keep squeezing it higher but it will be interesting to see how housing stocks can do if the market has a bad week.

Also watching silver and the yen to see if the dollar rally will run out of steam.

All in all not much to do.

Evaluating USD Strength

While the dollar is showing some strength on the smaller than expected trade deficit, I am not convinced it means a whole lot. I still tend to view Asia vs. Europe as the better risk trade but the U.S. is not fixing any of its longer term problems, so it will probably resume its downtrend eventually. The new budget (mentioned here via Brad Setser and here via Mark Thoma) is just adding to capital account needs and over time the trade numbers will reflect these policy mistakes.

Bill Cara explores the dollar's overnight strength and concludes with this:

I say that if the Bank of China does not revalue the Renminbi yuan this weekend, which is a longshot at best, there will be serious hedge fund failures next week. That's because traders like me are massively short the dollar and will have to close those positions.

Financial Armageddon just could be at hand, and we all were looking at the GM equity-bond trade issues as the biggest problem for some hedge funds when we should have been looking at the Dollar.

Traders cover losing bets all the time but hedge fund failures are a bit more infrequent. It is certainly in the air this week but with JPY below 136 to the EUR I am not sure people are that stressed. Below is a EUR/JPY chart with 4 hour bars.

Click on the chart to see a larger image!!
Posted by Hello

That seems like where the renminbi revaluation expectations have been most pronounced and probably where their is the most risk of a snapback. Greenspan's speech swung some weight behind the idea that China was facing internal pressures to revalue and that is a very persuasive argument for macro funds. The U.S. trade deficit doesn't seem like much of a catalyst in the trade. More of a distraction.

Summing Up the Week

We end the week weighing the auto downgrades and steepening yield curve (new 30-yr) against an unexpectedly positive jobs report and Kerkorian's bold bottom fishing maneuver in General Motors (GM).

On the auto downgrades it seems very likely that the bond market had already anticipated the downgrade. Its arrival shifts the focus off of the auto bonds and towards the wider bond market. I would not be surprised if GM and F bonds bottom here or shortly while junk spreads continue to widen. A best case would be junk widening while investment grade tightens but I would guess such a trend would be short lived. I am not really sure where Kerkorian's bid fits into this picture other than to muddy the waters. It is not clear what his motivations are and I am not sure that GM's equity is the best risk / reward trade in here.

I said any investment grade tightening might be short lived because the jobs report and new 30-yr created a lot of uncertainty in the long end of the yield curve. On Tuesday I thought the market would start to anticipate an end to the hiking cycle but this jobs report brings us back to considering 50 bp hikes. Easy to see why it was important for the Fed to reinsert a benign long-term inflation outlook. Anyway, the jobs report is just one data point and it needs confirmation in the rest of the data this month as well as next month's report. People were all about the "soft patch" at the beginning of the week so this report should cause a serious reexamination.

At some point between now and August the market will probably have serious doubts as to whether the 30-yr actually comes back. There are also supply constraints until the new bond is a sure thing so if the shorts get too heavy while it is only an idea that could set up quite a squeeze. A decision in August seems to put the new 30's issuance in Nov or Feb.

All this U.S. news has managed to crowd the yuan revaluation out of the news. Asian currencies are still trading strong though. Even though China does not want to reward speculators, the pressure internally are only going to get worse until they revalue. I thought they were coming to grips with that but maybe it takes another couple of months. They would need some help from Japan or Korea to scare the speculators at this point and I don't see much of a cause for that. The dollar also rallied nicely on the back of the jobs data but the theme to me is still European weakness. Gold and silver are focused on USD/EUR rather than JPY/USD. I am not sure why that is.

Japan has Diversification Plans Too

Bloomberg:

The dollar fell to a nine-week low against the euro after Japanese Prime Minister Junichiro Koizumi said today his country ``in general'' needs to consider diversifying its foreign currency reserves, the world's largest.
Koizumi said in response to a question at parliament ``it's necessary to diversify the investment destinations'' of reserves while ``considering what's profitable and what's stable.'' The dollar pared losses after a finance ministry official said Japan has no plan to shift its $820.5 billion of reserves, comments later echoed by Finance Minister Sadakazu Tanigaki.
``The market will believe Koizumi,'' said Steve Barrow, a currency strategist in London at Bear Stearns Cos. ``This is an issue that's not going to go away'' in the foreign-exchange market. ``That's going to undermine the dollar.''

Yen is still 104.2 but that statement is big news. The Euro hit 134.56 after the news.

The FT adds this:

Elsewhere is Asia, the South Korean won jumped Won13 against the dollar to a seven-year high of Won989.2 as Korea's consumer expectations index surged to its highest level since September 2002. This prompted Seoul to spend an estimated $2bn on intervening to buy dollar and send the won spinning back to Won1,000.2.
The New Zealand dollar rallied to a fresh 22-year high of $0.7449 against the greenback as the Reserve Bank hiked New Zealand interest rates by 25 basis points to 6.75 per cent, surprising the 50 per cent of the market that had been expecting rates to be held.

Back to Plan A

The Yen move lower now appears to be a headfake as it moved comfortably back into the pennant. Other currencies are still heading lower against the dollar and that has brought my attention back to those cross rates. I am going to be patient on my entries and look to short GBP / Yen again above 196. I am also looking at Euro / Yen for a short above 135.5. That will probably be it until late next week.

Here is summary of the overnight chatter causing the move. The GBP strength is being attibuted to a particular difference between British and U.S. opinions over debt forgiveness.

Rough Waters

I mentioned the won as being in the same boat at the yen a while back. Over the long run that should be true but this week they diverged a bit.

In contrast the South Korean won, another proxy for the renminbi, rose 1.3 per cent to a seven-year high of Won1,024 to the dollar as the central bank refrained from intervening.

The won strength also adds conviction to the idea that the yen will be strengthening shortly.

I see the GBP as the best currency to be short. Because of their weakening retail and housing market I expect them to start lowering rates soon.

Where I Stand

Currencies
Near the end of last year I put on a tiny Short GBP long Yen trade and I am now looking to exit and look for a bounce to reshort. I also reentered a short AUD long Yen trade when it got back below my original stop. I plan to just keep rolling down my stop there. EUR/Yen has moved below the 135 level which I considered an important breakout and I will now be looking to short that on a bounce as well. Through the great dollar rally of 2005 the Yen has barely budged and I simply don't trust the dollar long term against the currencies that have been supporting it these last couple of years.

Bonds
I have been outright wrong on interest rates in the U.S. for the last couple of months. I don't see how the market can continue shifting its estimates of short-term rates higher while the long-end stays down. If the market anticipates a slowdown why isn't it showing up in commodity prices or the equity markets? I continue to see it as an accident waiting to happen and would prefer to own foreign bonds for interest rate exposure. Either the Japanese short end or the European long-end with the currency hedged.

Stocks
The markets are in a good position now both in price and by the market psychology to resume the rally from last year. I would own companies that make something whether it is a technology product or machinery, I just prefer something physical. I am generally nervous about the financials because they are most exposed to a credit event. They have still not really reacted to the changes at Fannie Mae (FNM) or the general deteriorating credit of consumers. I am short-term bullish only and if I wasn't comfortable trading actively I would just be investing in a foreign stock or bond index.

Dollar positions

Keep in mind if you are short the dollar here that:

1. It is extremely oversold.
2. The DXY came very close to a key reversal day yesterday. It traded a lower low and reversed to a higher high but closed inside Wednesday's range.
3. The APEC meetings will provide an opportunity for everyone and their mom to weigh in on how horrible the dollar sell off has been for their country.
4. The March low in the the JPY is 103.42
5. Other trends of the last couple weeks appear to be hitting a turning point. The OSX put in a strong day Thusday while momentum seems to be failing in the SPX.

Weak yen

The bottom of this page has a story on the expected downward revision of the overall economic assessment for Japan by the Cabinet Office. Not really being talked about but the Yen weakness is striking.