Currency wars

The currency bloc has been relying on the largesse of foreigners to compensate for stinginess at home.

Could the collapse of covered interest rate parity be the harbinger of even stranger things to come ? At the heart of the issue is how on earth the interest rate differential between two currencies in the cash money markets is no longer equal to the differential between the forward and spot exchange rates.

China will join the exclusive club of “hard currency” issuing countries when its currency, the renminbi, becomes a fully fledged member of the IMF’s special drawing right basket on October 1.

An odd theory has been making its way around for months, and we’ve been surprised by how many people believe it. The theory is this: Central bankers made a secret back-room deal at the G20 meeting in Shanghai in March February to let foreign currencies appreciate against the dollar, to calm global financial markets that were roiled by China’s currency devaluation a year ago.

It’s 1998 again in emerging markets, and it’s good: The best parallel with recent events – major shock (this time, the UK vote), DM central bank liquidity reassurance and market surge – is, in our view, the collapse of Long-Term Capital Management (LTCM) in September 1998. In addition to a bailout for LTCM, the Fed ‘turned on a dime’ then and cut rates by 75bp in two months; risk markets took off. While MSCI GEMs fell much more before Sept. 1998 (Asia and Russian crises) than recently, EM rose by 31% in two months after LTCM and by 120% by March 2000. As usual, the USD played a role; after a four-year 34% rally to August 1998, the $ TWI fell by 11% after LTCM. The extremes will be hard to repeat, but the earlier episode confirms how liquidity is a ‘great healer’…

The SEC has issued a cease and desist order against Bitcoin Investment Trust (BIT) and SecondMarket, both founded by Digital Currency Group CEO Barry Silbert — and dubbed back in September 2013 by the NY Times’ Peter Lattman and Nathanial Popper as “a reliable and easy way to bet on the future price of bitcoin”. The Trust famously beat the Winklevoss brothers’ bitcoin ETF to market and drew significant column inches as a result. The Winklevoss ETF (for some strange reason associated possibly with risk?) is yet to receive regulatory approval, forcing the brothers to make significant amendments to their original regulatory filing if it’s to stand a chance of being approved.

For a company that prides itself on transparent fee structures, Transferwise — the UK-based FX money transmitting unicorn — has a fairly opaque way of delivering attractive exchange rates. Competitors who have tried to reverse engineer TW’s rates have struggled, not least because pure brokerage models are not supposed to take principal trading risk when they aren’t able to immediately match buyers and sellers in the market. To the contrary, they pass orders onto the wholesale interbank market through properly licensed institutions who take on the risk of supply/demand imbalances in their place. But this, alas, means brokers have to factor in the cost of wholesale liquidity, which inadvertently puts a floor on how low their own customer fees can go (at least if they plan to break-even).

We recently had a chance to chat with a senior Canadian economic policymaker. Among other topics — he estimated fiscal stimulus would boost growth by around half a percentage point in 2016 and by a full percentage point in 2017 — we discussed his belief the depreciation of Canada’s currency could help export growth offset some of the weakness in the oil economy. What follows is an attempt to assess Canada’s progress so far. For context, the Canadian dollar has lost about 21.5 per cent of its value against the currencies of its trading partners since the most recent peak in mid-2011, although the loonie had dropped as much as 31 per cent before the recent rally in risky assets:

From BofAML’s FX strategist Athanasios Vamvakidis, do click to enlarge:

The first question is whether there was a lovely new, but secret, currency accord agreed at the G20 in Shanghai in February. The answer is: Probably not.

This post will be made up of two pieces. The first will try to explain why JPY continues to defy Japan’s negative rate-led demand for currency weakness. The second will add words to this picture from HSBC which proclaims a break in the (so-called, he adds hastily) currency wars, predicated mostly on said JPY strength: At last sighting JPY was hovering at about Y108. That’s not good if you are the BoJ’s Kuroda or the overarching Abe, particularly because FX strength can beget more FX strength. The question is why did the yen start this slide:

An important question for anyone who thinks the euro area needs to keep its currency weak to grab foreign demand. Or who thinks that’s what the ECB thinks, anyway.

Bloomberg went to town this week on news that hedge funds may be piling into USTs to the total tune of $1.27tn in lieu of foreign central banks and finance ministries who for the first time since 2000 have — on an annual basis — been holding off from making further investments. On March 15, US Treasury International Capital system data confirmed that foreigners sold $50.4bn in Treasuries on a net basis in January. But! foreign central bank holdings of US Treasuries actually grew to $6.183tn in January. But there are discrepancies to consider.

“I don’t think this is a meeting where there will be some big decision,” said one G20 official who asked not to be identified, presumably not because he fears reprisal from an IMF which advocated a plan “for co-ordinated demand support using available fiscal space to boost public investment and complement structural reforms.” So that’s probably that for now. What about the FX bit?

Paul Donovan’s team at UBS was one of the first to highlight the recent trend towards deglobalisation, but also how the phenomenon links into the capital flow reversal story. It’s a big deal. We think. (So much so, we’re planning a dedicated panel on the topic at this summer’s Camp Alphaville, so do watch this space). The trend, in any case, is certainly not subsiding (as yet). On Thursday, Donovan and co. were back with a note explaining why. There make three core observations:

For a given definition of winter*, naturally. From Willem Buiter and team at Citi on why the risk of a global growth recession is high and rising, with our emphasis: The growing threat to the global outlook rests on poor fundamentals, which include the pre-existing fragilities related to the structural and cyclical slowdowns in China and its unsustainable currency regime, broken EM growth models, excessive leverage across many countries and sectors, and rising regional risks (Brexit) and geopolitical risks (including in Russia, Turkey and Syria, the South China Sea, and North Korea).

Are shrinking Chinese government FX reserves a sign of capital flight or are they just a public-to-private asset swap? Here’s a chart from Nomura’s Asia Insights team to mull over whilst considering that question. Pay attention to the net foreign asset entry line in particular:

By Nomura first, who are worried that Japan’s economy has taken a dangerous turn — what with GDP dropping at an annualised rate of 1.4 per cent in the fourth quarter and Abenomics being felt for a pulse:

Imagine someone told you about a country where real output per person is at an all-time high and growing at an increasingly rapid pace, its employment rate is at the highest level in decades, the country’s housing sector is on fire, and its current account surplus is about 6 per cent of GDP. In the absence of other information, would you say this country should be: If you answered yes to the above questions, congratulations! You’ve just described the behaviour of the Sveriges Riksbank. From their policy announcement on Thursday (our emphasis):

Chinese FX reserves are down to a three-year low according to figures released this weekend. But, if like us, you trace the current drawdowns to dynamics which first emerged at the end of December 2011… then you might find the following chart from Macquarie Bank’s global equities team of interest:

Which leads us, naturally, to a partial Fed transcript from August 1985:

When things get too expensive, imperfect substitutes become increasingly appealing. It happened to oil with natgas and shale. It happened to gold with copper and silver. Now it seems to be happening with Bitcoin as well. So while Bitcoin traded through $1,000 on Wednesday (depending on which exchange or service you use to acquire Bitcoin: it was $1,035 on MTGox, $922 on BTC-e at pixel time), more interesting is the recent surge that’s taking place in the value of alternative crypto currency Litecoin:

It’s called Pope Francis’s apostolic exhortation … … and judging by some of its contents, it’s the boldest papal critique of market fundamentalism yet:

Crises tend to be born out of the unexpected and the thing most people just don’t see coming. Nassim Taleb taught us that. With all eyes on western central banks, QE, accusations of Western repression — and a repetitive dialogue that it’s QE that’s causing bubbles everywhere — we’d argue the markets may be missing a trick in neglecting the importance of China’s recent turn towards liberalisation. But not necessarily for the reason most people think.

We were going to be slightly snarky in the face of Zhou Xiaochuan, head of the People’s Bank of China, promising to “basically” end normal intervention in the currency markets and other such liberalising things — the lack of a timetable and the ambiguity of phrasing making this seem rather similar to what we’ve heard in the past — but then we saw this from Neil Mellor at BoNYM and felt bad: However, although a timetable was absent from Mr Zhou’s brief – something we discuss below – the fact is that this announcement constituted the beginnings of a new era for financial markets and no superlative would overstate its significance. Oops.

He’s dead, of course, professionally. Former chief FX dealer for JP Morgan in London, Richard Usher. Bloomberg has the glee: …wrote instant messages while he was at Royal Bank of Scotland Group Plc (RBS) that U.K. regulators are scrutinizing as part of their investigation of alleged currency manipulation, two people with knowledge of the matter said.

Abundant flows of global capital in search of fresh yield are unstoppable but unabsorbable. The imposition of new capital controls is often appropriate but, nearly as often, ineffectual.