A Forex View From Afar

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Preparing for the BoJ

Written by A Forex View From Afar on Wednesday, March 18, 2009

Financial markets will be waiting for the Bank of Japan’s (BOJ) press conference during the upcoming Asian session. The press conference follows closely behind the bank’s two day meeting.

The bank’s task will now be to stimulate a falling economy, but without the help of monetary policy. The ultra-low rate of 0.10% stops the BoJ from lowering the interest rate any further, practically putting conventional monetary policy on the sideline. As such, the bank must conceive new ways to stimulate the economy, and help the Japanese financial system. In past meetings, the bank referred to the measures taken as “exceptional for a central bank”

Some of these measures include providing dollar liquidity, intervening in the corporate market, and extending the range of assets accepted as collateral. Additionally, the central bank pledges to buy preferred shares issued by banks, and buying publicly listed shares held on the bank’s balance sheets. However, the last two actions failed because of the Japanese corporate business environment which led to the appearance of zombie banks during Japan’s “lost decade”.

In a new attempt to help the financial system, the BoJ announced that it would provide as much as $10 billion in subordinated debt. Subordinated debt, or junior debt, is among the riskiest forms of lending. In case of a bankruptcy, subordinated debt is the last that gets paid (if funds are still available); on the other hand, senior debt is the first to be paid in case of a bankruptcy.

There have been no further details about the new BoJ plan, but it will most likely be included in the upcoming statement. Chances are that the bank will ask the BoJ staff to analyze the implementation, as has been the case in the past.

The success of the new subordinated lending program is not assured. One reason is that it will hit the same Japanese corporate environment, in which banks refuse any help from the government so as not to affect their reputation. In a time when most of the U.S./European financial systems have survived only by being helped by the government, it is hard to envision any investors actually considering their reputation.
However, past experiences have proved the inflexibility of the Japanese corporate environment, so another failure would not come as a surprise.

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The Chinese Conundrum

Written by A Forex View From Afar on Sunday, March 15, 2009

Before the G20 conference this past weekend, top Chinese officials had complained about the safety of the U.S. Treasuries.

Being by far the largest U.S. bondholder, China has a lot of influence over the debt market. It is said that, the People’s Bank of China holds up to $1 trillion in Treasury notes and government-backed debt, issued by public/private entities like Freddie and Fannie.

It is easy to see why the Chinese government is concerned about the fate of U.S. debt, since such a huge amount of debt holds two major risks: interest rate risk and currency risk. Bonds have a unique relationship between its price and yield, as one rises the other drops. As such, if the yield rises on a bond, its price would fall. Here is where the Fed comes in play.

Eventually, the Fed would have to raise the interest rate, even though this might not happen in the near (or medium) future. A higher interest rate would drag the price of U.S. Treasuries lower, while increasing its yield. From such a move, the Chinese foreign reserves would take a hard hit, because U.S. bonds will lose their value.

Another hit that China might take comes from currency risk. U.S. Treasuries are denominated in dollars, and a steep depreciation of the greenback would pose a huge risk, even though many say the Usd/Cny rate is manipulated.

Neither of these two outcomes are likely to happen in the short term, but as the credit crisis comes to an end and things start to return to normal, money will start pouring out of the U.S. economy in search of higher yields. As such, the dollar and Treasuries will be certain victims, something that should worry the Chinese officials.

Currently, Chinese officials cannot do too much about it, but in time, they will have to begin to diversify from U.S. debt. One of the golden rules of building a successful portfolio is to diversify, something that they have not done, and now the State Administration is paying the price for this. Most analysts say that, President Obama will have a huge problem funding the federal deficit if China was not buying Treasuries.

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Euro-zone rate cuts may be nearing an end

Written by A Forex View From Afar on Tuesday, March 10, 2009

A rather surprising announcement was made today by Mr. Axel Weber, the head of the Bundesbank. The Chairman said at a press conference held in Frankfurt that he sees no need for interest rates to fall below 1%.

Being the largest central bank from the Euro-area and one of the initial founders of the European Central Bank, the Bundesbank certainly has a huge influence over the monetary policy of the ECB. As such, Mr. Weber’s comments can easily be taken as the position of the ECB.

Additionally, the Bundesbank has changed the face of monetary policy by managing to keep inflation down at a time when every major economy in the world had double digit Consumer Price Inflation (CPI). The Bundesbank’s strategy was to anchor expectations by using public speeches and appearances, a strategy that was later used by most central banks to guide expectations (and is still being used).

Over the past few months, ECB officials have repeated that they do not see the need to send the interest rates too low, because it would risk drying up the inter-banking funds. However, this view is not shared by most market participants, who strongly believe that the ECB is way behind the curve on lowering rates.

The main “counterexample” for the ECB’s actions is the Fed, which cut rates as much as it could at a breath-taking pace. The Fed’s view is influenced by a number of academic papers, which say that if the Fed would have cut more in the 1930’s, the U.S. economy may have avoided the Great Depression. This view is strongly supported by Mr. Bernanke, but Nobel winner Paul Krugman has stated lately that this strategy has failed to do anything new. Additionally, the U.S. economy is starting more and more the look like Japan of the 1990’s.

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Can The ECB Cut More Than Expected

Written by A Forex View From Afar on Thursday, March 05, 2009

Tomorrow morning every market participant expects the ECB to reduce the overnight lending rate by 50 basis points, down to 1.50%.

The road to such a low rate was somewhat lengthy for the European Central Bank, compared with the other major central banks, of which almost all are preparing to adopt a quantitative easing strategy.

Until now, the foremost members of the ECB’s voting council have excluded the possibility for very low interest rates. In their opinion, low, real, inter-banking rates would create a liquidity trap, which means that the central bank would reach the limits of monetary policy. At the same time, a liquidity trap would drain any lending in the inter-banking system because of the losses banks would have to take when they borrow or even when they lend. In other words, it would be cheaper for the bank to keep the money for itself than to lend it to another bank, something that has widespread negative effects in the real economy.

For this reason, the Eonia Swap market is pricing in a 0.75% interest rate in the following 3 to 12 months, after which traders expect the bank to begin to slowly raise the key interest rate. Interesting enough, the same Eonia Swap rate, which to some extent is the future market for the ECB rate, began to price in a 1.25% interest rate for tomorrow’s meeting, since the last part of January.

This means that the spread between the forecasted interest rate and the 1-week Eonia Swap rate is -25 basis points, the largest in the current rate cut cycle. This is a sign that prime banks, the ones that trade in the Euro-area inter-banking system, expect the ECB to cut 75 basis points tomorrow. At past meetings, the spread between the two rates was positive.

Also tomorrow, the ECB is expected to update its growth and inflation projections for 2009, also known as the “staff projections”. As has been announced by Mr. Trichet in his speeches, the forecasts will be downgraded considerably from the previous numbers, something that might have a negative effect on the euro’s valuation

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ECB And BOE Face Tough Decisions

Written by A Forex View From Afar on Tuesday, March 03, 2009

Ahead of the interest rate decisions on Thursday from the two major central banks in Europe, the ECB and BoE, the market is looking for a direction where the two might be heading.

In mainland Europe, the ECB’s task is becoming tougher as the credit crunch intensifies, on top of the strong criticism it receives from almost every economist because it reduced the interest rates at too slow a pace.

One of the main concerns of the ECB is to reduce the spread between the German Bunds, which are seen as the safest from the region, and the rest of the member countries, especially Greece, Ireland, Spain and Italy. The ECB cannot intervene directly in the Euro-area debt market, but it can influence the demand and the supply side in the secondary market.

Even though the EU regulations are out of the ECB’s reach, the central bank might get help from them. The European Union treaty forbids any member country to have a budget deficit equal or larger than 3% on the long term. To some extent, this means that the government should follow strict fiscal policies, something that would help bring the yields on the government debt somewhat lower.

Additional help might also come from the European Union to reduce the government yields in Europe. Following a call from Germany last week, today, commissioner Almunia said that the EU would not let down any Eastern European state in case its situation worsens and it will bail it out the country before any international institution will, like the IMF. In the last few weeks, investors grew more nervous about the fate of Eastern Europe.

In the U.K., things are starting to point to the BoE will join the Fed and the BoJ into quantitative easing. Today, the Chancellor of the Exchequer, Alistair Darling, said that the central bank has a green light from the government in expanding its balance sheets. The BoE has the approval to print up to $283 billion that would be used to buy government debt and presumably, some high graded corporate debt. In the two day meeting, the Monetary Policy Committee is expected to announce if this measure was approved, with most market participants saying that this decision would be approved very easily.

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Financials continue to struggle

Written by A Forex View From Afar on Monday, March 02, 2009

The financial stocks continue to drag the major market indexes lower, as their fate becomes more uncertain with each passing day.

Today’s victims in Europe were clearly HSBC and Lloyds, which both lost more than 15%. Lloyds has depreciated about 90% from one year ago, while HSBC lost 44%, a smaller decline because the bank is among the few that still reports profits and refused any government help. In the U.S., Citigroup and Bank of America plunged 20% and 14% respectively today. The selling wave came as AIG received its fourth bailout from the U.S. government. Some of the details from the first three bailouts are still uncertain, and a rising number of analysts say that in this deal profits are privatized while the risks are being nationalized.

AIG’s shares have plunged 99% over the last year going above the borders of bankruptcy, to some extent. However, today, the insurer got a very good deal. It managed to change the conditions on a 40-billion investment made earlier by the Treasury, exchanging preferred shares to non-dividend paying shares. On top of this, the Treasury will buy another $30 billion worth of AIG shares, which will most likely be dividend-free, and shrink some previous credit lines from the Treasury in exchange of some illiquid and most likely worthless assets.

From one point of view, it looks like AIG booked a very good deal today. However, the question that comes to everyone’s mind right now is if this would be the last bailout AIG gets, and how good this deal was for the taxpayers. According to the latest forecasts, the downturn will continue well into the third and the fourth quarters, so it is hard to expect any improvements in the financial markets, something that would eventually really help the banking sector.

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Trade Desk View

Fundies and Trading
There is a constant question from some traders as to why anybody would ever need to consider the ‘F’ word when trading. Fundamentals: what is so damaging at looking at both Technical charts and having a Fundamental filter to gauge how many Lots to put on? Why is it that accepting that Technicals give us price points to trade, but Fundamentals determine the direction that we travel is so difficult for some traders to accept? Without a Fundamental Filter very few pure Technical traders would have seen this Dollar move coming today.

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