Seven Charts and a Curious Conclusion

I’m confused. “Well”, i hear you say, “there’s a surprise!”

Since Uncle Ben announced it latest round of debt monetization (QE2) the dollar has strengthened against the Yen. Not by much, but it has been consistently in one direction. Obviously this will change now that i’ve mentioned it…

This article has (you guessed it) seven charts of the dollars performance against various currencies. I’ve never been able to get much out of, so called, technical analysis. In fact, it’s usually translated in my head to ‘testicle analysis’ as it seems to be only so much bollocks…

That being said, the following chart of dollar / yen since 1976 indicates to me that there is basically one relentless trend:

If you were going to bet on one thing based on that chart it would probably be that the yen is going to continue to strengthen against the dollar. The last couple of decades of deflation in Japan have provided some respite for the yen, but with the comparison being between a contracting US (with a massively negative trade balance, and a money printing, actively dollar debasing, Fed) and a moderately deflating Japan, it’s obvious that we’d be testing new lows.

All of which makes the following conclusion to the article:

The key take-away: A grossly weaker dollar is not an economically or politically acceptable proposition for the world. And trouble for the world economy represents trouble for the U.S. economy.

So, despite all of the bold projections of a continued rout in the dollar, these seven charts suggest the exact opposite outcome could be around the corner.

Wha?

The missing piece, in what i’ve said above, appears to be the following chart:

which shows the relative values of currencies (against the dollar?) The Yuan is the obvious standout here – over the period of the chart it has risen only modestly, which everything else (of import in the world of currencies) has headed for the roof. This makes chinese export (relatively) more (price) competitive.

The argument is presumably that this collective need for a strong dollar (it is after all the world reserve currency, not just the currency of the US) will override the desire of the US to devalue the dollar, to boost exports. I’d have more sympathy for this argument if the US was an export powerhouse, but that hasn’t been the case since the 50s, and there are only so many wars you can ferment to increase arms sales… and when something like 80% of your manufacturing base is in the “defence sector” that’s a reasonable consideration!

Thus far the collective desire for a strong dollar has not amounted to much, unless one assumes that it has been a case of attempting to ‘talk the dollar up’, an no real action has been taken.

There we are: i’m confused. The dollar is obviously weak and i can see no reason why it should not continue to weaken. However, it’s strengthening, and  people are convinced that this is to be expected.

Don’t know what to think… except that markets can’t be rational if they are based in the complex (and irrational) behaviours of traders following there hunches and muses!

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Bond Talk

There has been more bond talk[1] this weekend. The following rather cryptic (in my opinion) Reuters wire snippet has a lot of people worrying:

[11:41 US GOVTS: Real Money Using Coupon Passes To Exit; FM Blast]

Boston, May 21. There apparently is a new wrinkle to the intermediation trade between buying from Treasury to sell to the Fed with real money, including central banks, now in on the act. Indeed, several Street sources relay central banks were aggressive offers into this morning’s coupon pass, with one letting go of a large block of old 5-years. Other offers too are coming in from embedded Asian real money longs — in the higher coupons — also looking to sell size without unduly upsetting the market, and especially considering the illiquidity in off- the-run bids from the Street.

Which pretty much says that central banks (European and Asian) are using the US Treasury’s bond auctions to dump existing holdings. Meaning that they are getting creative at dumping long term treasuries, without unduly freaking the market.

Denninger comments:

So now what Ben?

If Foreign Central Banks are selling into Ben’s bid then the game is literally weeks or even days away from being over.

I have written for over a year about the potential for a bond-market implosion and subsequent economic collapse.

and i can see why he might think that… if the real money is looking for the exits, the Fed will be left holding all the long term (10 to 30 year?) debt, with the rest of the world closing out at short-end.

However, i don’t think this game is going to play out in the suddenly apocalyptic fashion that people like Denninger (and many like him) fear. The holders of these bonds (mostly China, Japan, and other asian central banks) know that if they crash the dollar, debt they hold is going to be worthless. My guess is that they are going to push this as far as they can without actually letting it break. Over time they’ll push the yield higher and higher, hoping that they can bleed America dry without actually sending it into cardiac arrest.

If you’ve been watching the yield on the ten and thirty year you’ll see that they are still heading up. And that has to be halted or it’ll set off a next wave of defaults in the housing market… certainly agree with the question, “So now what Ben?”

As an aside, there are a bunch of stories[2] out there about the rating agencies (S&P, Moodys, Fitch, etc) downgrading the national debts of the US, UK, and Japan. This looks like a side- show to me – these are the same clowns who stuck AAA ratings on MBSs, and obviously don’t understand that Japan doesn’t give a flying about it’s debt rating because it’s not borrowing externally… ignore it, and keep an eye on that bond yield!

[As always, Cynicus Economicus is worth a read.]

1. Bond market Week of Reckoning, Lighten upBond Market To Bernanke and Obama: F&$k You

2. UK credit rating under threat as debt hits £8.5bnWhy US Debt Rating Poses Such a Big Worry to InvestorsTreasurys fall further ahead of auctions

Unyielding

30 year bondBeen watching this graph recently – it has been behaving badly…

That’s the yield on the US Treasury 30 year Bond. You can see the yield being forced down 2%, to 2.5%, from November to the end of last year. Then it creeps back up to 3.5% over a period of several months, where it stabilises until mid-April. At which point it starts to slowly, relentlessly creep back up. All of which raises some interesting questions, like ‘what’s happening?!’, and ‘what does it all mean?!’.

That graph shows the interest rate (yield) that the government has to pay on it’s debt. The more worried that ‘the market’ is about the amount of money that the Treasury wants to sell, the higher this yield moves.

Which would be simple, but of course, things are never allowed to be simple. In order to have some control over the rate, the Federal Reserve (central bank) can print up some new money, and buy the debt from the Treasury.

Unfortunately this ruse doesn’t appear to be working, as you can see – the rate is moving up. How can this be? Surely the Federal Reserve is so powerful, in theory being able to print an unlimited amount of money, there should be no limit to the scope of it’s action.

The problem for the Fed is that the more money that they print, the more the damage the value of the currency. The more they damage the value of the currency, the higher they would be forced to push interest rates to protect it. Not doing so risks crashing the currency, which when we are talking about the dollar is a big deal. The world holds trillions of dollars in reserves, and would not take kindly to having it rapidly devalued.

Another option is to squeeze money out of the equity / stock markets. Money exiting the stock market, seeking safe haven in the bond markets would help stabilise the yield. Or at least that’s the theory… in  my mind it doesn’t really work, or to the extent that it does, is of marginal effect. Someone holding stock decides to sell it, and move the funds into treasuries. For this to happen a second party must be on the other side of the transaction, and buy the stock. Where is the extra money coming from?

It’s possible to argue that the extra money is cash that is sitting on the sidelines (Sideline Cash Myth) but this doesn’t seem to stand up to much examination.

It seems to me that this puts us back in our usual position: between a rock and hard place. On one hand the government needs to finance debt in order to attempt to stimulate the economy / compensate for all the money being destroyed as debts go bad, interest rates need to stay low to keep this debt affordable, and reduce financing costs. And on the other, the currency needs to be protected or the market will not be willing to buy the the additional debt due to low yield, and fears of default.

Therefore the governments of the west are attempting to keep the system ticking along in the hope that enough growth will return to allow the debts to be paid down. At this point in the cycle, the debts are so huge that, i believe, this is no longer possible, or is at best, extremely unlikely.

Keep an eye on that graph. Nothing radical is going to happen now, but i suggest this is how you’ll know who (the central banks or the markets) is “winning” the war.

As an aside, a lot of this talk is about the dollar, but that’s mostly because it the easiest set of data to work with. The same situation is playing out in the other western economies, and the various central banks are fighting the same battle. The interesting exception to this rule, as always it seems, is the Bank of Japan, which despite printing money like it’s going out of fashion, has kept the yield on the japanese long bond remarkably stable. Again, as usual, i don’t understand the mechanism by which this can be explained…