2015 DRIVERS - 5 Macro Themes to Watch
"Macro is back, and 2015 is shaping up to be an epic year for the guys who trade these fundamental shifts. To a man, after several years of little action in the macro world, they are positively licking their lips at the potential opportunities that are headed their way next year." - Grant Williams
1- Big Things Happen - When Currency Markets Re-Allign
“When currencies begin to trend, they can do so for decades.”
Currencies trade approximately $5.3T per day. with nearly $200T in SWAPs alone. The total size of the Bond market is approximately $100T. The Global Equity markets is a small $50T. Currencies shifts and King Dollar often dictate major Global Macro movements.
"King Dollar, and the world’s reserve currency is making some serious waves right now, which threaten to cause chaos in world markets. Debt dynamics, deflation, positioning and technicals all suggest that a dollar bull market of some considerable velocity and length is underway.
- When dollar bull markets occur, emerging markets get hit.
- When dollar bull markets occur, carry trades get unwound.
- When dollar bull markets occur, they tend to usher in disinflationary forces as commodities and goods get re-priced.
The preceding three factors lead to a self-reinforcing of the dollar bull market, creating more of the same in a cycle of liquidation and bad debts, creating more demand for US dollars."
The Global Macro Investor, Raoul Pal
A look at the long-term charts of the DXY Index shows just how massive the potential reversal of this trend is. The sheer size of the reversal gives us a strong hint of the degree of carnage that will be wrought upon a world in which the dollar carry trade has reached somewhere between $5 trillion and $9 trillion.
MASSIVE SHORT SQUEEZE
To borrow in a currency is equivalent to shorting a currency. The US$ loans borrowed are sold in exchange for local currency. Local currencies consequentially rose.
Asian Sovereign's after the 1997 Asian Crisis learned to hold higher reserves in case this "hot money" reversed to stop the local currency from subsequently plummeting.
The "Cardinal Sin" of Carry Trade is to trade in a currency that might rise. The "Carry" needs to be in a currency that is expected to depreciate. The US dollar has been expected to fall by analysts since the 2008 financial crisis.
Presently, as the US$ rises the $9T 'Carry' is on the wrong side of the trade which must be covered or hedged - FAST.
According to the BIS' latest report, US dollar loans to China’s banks and companies have jumped to $1.1 trillion — that’s TRILLION — from virtually zero just five short years ago. The annual rate of increase of those loans is a mind-boggling 47%.
Grant Williams points out the following:
"Consider Brazil, for example, where cross-border dollar credit now stands at $461 billion, or roughly 20% of GDP. For Mexico those numbers are even more eye-watering. A country with a GDP of just $1.1 trillion has outstanding cross-border dollar credit of $381 billion — or roughly 30% of GDP. Frightening.
Meanwhile, in Russia the same metric has reached $751 billion. Why does this matter? Well, the charts below, which show the appreciation of the US dollar against those three currencies in the last five years, highlight the danger to countries that have been able to borrow seemingly endless amounts of (relatively) stable dollars to finance business operations and expansion.
Lastly — and perhaps most importantly — witness the change in direction of the Chinese renminbi which, after trending higher against the dollar for many years (and, in the process, moving virtually everybody to the same side of the boat in the belief that a stronger Chinese currency was a given), has suddenly started to look as if it may also succumb to the renewed strength of the dollar. The only difference here being that the Chinese may actively be looking now to devalue their currency in light of the ongoing attempt by the Japanese to devalue their way back to competitiveness. Few thought this a likely scenario until very recently; consequently, few are positioned accordingly; and when things like that happen in the macro world, you can get some REALLY funky moves."
When currency wars break out, they can get very nasty very quickly.
Under no circumstances should you take your eyes off the US dollar, folks. The sheer number of places where you will witness the knock-on effects of a soaring dollar — chief amongst them emerging markets and the commodity space — will be breathtaking.
TO BE CONTINUED WITH #2 TOMORROW
2015 DRIVERS - 5 Macro Themes to Watch
- Big Things Happen - When Currency Markets Re-Align,
- Big Things Happen - When Liquidity Flows Change Significantly,
- Big Things Happen - When Geo-Political Conflicts Dominate the Nightly News SoundBites,
- Big Things Happen - When Investment Greed and Euphoria SHIFTS to Fear and Panic,
- Big Things Happen - When Collateral Contagion, Counter Party Risk and Margin Calls Increase.
A WITCH'S BREW
The result of the 5 themes above is a concoction that is 'unwittingly' being formulated by world leaders and central banks