Currency Currents

Key News

• As the dollar skids, dropping earlier this month to a 12-year low against the yen and another record low against the euro, U.S. exports are surging. That is providing a lone bright spot in an otherwise-gloomy economy and distinguishing this downturn from the last recession. (WSJ)
• Confidence among Japanese manufacturers fell to the lowest level in at least four years, as a surging yen and the risk of a U.S. recession clouds the outlook for the export-led expansion. (Bloomberg)

Key Reports Due (WSJ):

• 8:30a.m. Chicago Fed Natl Activity Index. Previous: -0.58.
• 10:00a.m. Feb Existing Home Sales. Expected: -0.8%. Previous: -0.4%.

Quotable

“A wise man proportions his belief to the evidence”

David Hume

FX Trading - Key theme hodgepodge and points of interest bites

Just maybe the dollar can bounce. Benefiting from:

• Confidence that market liquidity is back, now that the Fed is backstopping not only banks, but investment banks. This might provide stock market support, and improve US consumer sentiment near term. If so, we would expect rates to edge higher (prices lower). Below is a chart of Eurodollar futures (prices fall as rates increase and vice versa) vs. US $ Index. The Elliott Wave numbering for the Eurodollar is attached…

• A commodities correction, though long-term supply and demand characteristics suggest this bull is still alive
• A vigorous correction would likely:
• Increase expectation of rate relief in the UK and Eurozone
• Further improve US current account view should oil prices decline too

• A bouncing dollar might mute current high expectations of Gulf States de-pegging from the buck, fearing they are doing so near a dollar low; improved sentiment here would be very dollar positive (this is not to say pegs don't come off sometime down the road)

Is this only dollar bounce stuff? It's probably too early to suggest the dollar bottom is in place. Sentiment, in terms of overall positioning levels (currency open interest traded on the CME), are still not at a crystallizing extreme. And if Fed action once again proves inadequate, the dollar likely tanks yet again.

But, we need to remain open to the unexpected. And we rank a couple of unexpected events up there:

• European banking problems and lack of decent cross-border mechanisms so stem pain (see the list of ills below)
• Decline in Chinese demand near-term

Some points of interest from The Economist:

• Bear Stearns had $10 Trillion in derivatives exposure. JP Morgan was the counterparty on much of that.
• Goldman has $40 billion of equity as a foundation for $1.1 trillion in assets; Merrill Lynch has $30 billion supporting $1 trillion in assets
• In inflation-adjusted terms, a rate of ¥100 to the dollar is equivalent to ¥125-130 a decade ago, according to Eisuke Sakakibara (aka “Mr. Yen” for managing Japan's currency interventions from 1997 to 1999 at the Ministry of Finance). (Economist)

European Banking Troubles Brewing? (Thanks Jan)

• FT: On February Financial Stability Forum urges prompt writedowns and warned that the full impact of the credit squeeze had yet to be felt around the world. Banks wrote down $140bn by Q4 ($84bn in U.S., about $40bn in Europe) subprime securities so far, finance ministers expect $400bn. Half of it expected in U.S., other half rest of world.
• Fitch: Basel II rules allow easier accounting clean break with off-balance sheet vehicles--> eventual re-intermediation may occur all at once
• SIFMA: Outstanding volume for the European securitization market stood at €1.32 trillion, as of 30 September 2007. Euro-denominated CDO market volume 2004-2007= €285.4bn (around $410bn)
• Tett: EU banks rumored to be slower with hung LBO debt writedowns.
• WSJ: EU banks reported to be exposed to monoliners via popular 'negative basis trades' in past few years (arbitrage opportunity technically due to oversupply when CDS spread (i.e. cost to buy protection) on a single name is smaller than the bond yield--> buy both bond and protection from monoliner and cash in the risk-free spread difference.)

• 6 banks out of 8 planning monoline rescue were European; expected losses in $20-140bn range

• European banks also reported to be exposed to commercial real estate loans/CMBS and leveraged loans stemming from buy-out boom. These markets are turning now and additional writedowns are expected ($100-200bn)
• UK, Spain, Ireland financial sector additionally exposed to domestic housing bust--> Spanish banks e.g. less exposed to U.S. subprime fallout and off-balance sheet SIVs but draws heavily on ECB lending facility which delays actual writedowns on unviable collateral (RGE)
• from http://www.rgemonitor.com/10009?cluster_id=8780

Jack Crooks
Black Swan Capital
http://www.blackswantrading.com

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