Meltup Monitor: Euro Pressure Going Critical - 28- Nov 2013
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FLOWS: The Currency Cartel Carry Cycle
Since 2008 the single-minded focus of central banks has been the repair of the balance sheets of the major international banks and sustaining the debt addicted funding for sovereigns consuming more than they produce, reeling from slow growth and chronic unemployment and incapable of fashioning Fiscal, Public & Economic Policy solutions. In the world of the blind, one eyed Monetary Policy has become King!
The urgently growing problem now is a crisis in the global pension industry. The Macro Prudential strategy of Financial Repression (negative real rates, penalized savings, regulatory arbitrage and currency debasement) has worked effectively for the banks and sovereign governments but has left those industries requiring ‘yield’ in dire straits. It cannot be stressed enough how important pension and insurance investments are to the life blood of the global economy. Banks may get the press but those less understood, toiling in the shadows, keep massive economic segments such as commercial real estate (temporarily)afloat.
The solution has been for these financial intermediaries to change regulatory and fiduciary risk restrictions and increase riskier equity asset allocations. The magnitude of underfunded pensions, the growing disconnect of the “8%” rule and the tsunami of retirees now beginning to make claims is forcing the liquidity pumps to be sped up – not “tapered’. A ‘Madoff Moment’ is near without continuing and uninterrupted flows (see: “FLOWS: Liquidity, Credit & Debt” for detail).
EURO PRESSURE NEEDS RELIEF
The equity markets in Europe and the US have been on a tear as the new world of ABE-nomics reignited the dormant Japanese Carry trade and helped the pension industry in a stealth fashion.
The correlations are indisputable. Even Goldman Sachs recently outlined it couldn’t explain a 22% differential between what its combined Macro, Valuation and Risk models suggested the S&P 500 should be trading at.
The new problem is the strength of the Euro.
The Euro is seen to now be stalling the EU recovery and potentially triggering another EU banking crisis as CEE (Central and Eastern European) loans (denominated in Euros), are rapidly becoming non-performing. (See: “ Euro Pressure Going Critical“)
NOWHERE TO HIDE – NOWHERE TO RUN
The “Carry” trade has been in full force since the 2000 technology bubble burst. For 80 months a 41.6% devaluation in the US dollar powered a US$ Carry Trade with low interest rates. With the financial crisis the Carry Trade shifted and the Euro Carry emerged with 24.0% currency devaluation over a 51 month period. Since October 2011 the Yen has resurfaced as the excepted Carry Trade. It needs to be appreciated that this is a planned rotation by the currency cartel, which controls 90% of the globe’s currency trade.
As long as the Cartel all debase together, in a coordinated ‘rotating’ fashion, there is seen to be nowhere to hide!
Everyone is presently focused on the central bank balance sheet growth. We did earlier as we identified very coordinated patterns during 2010 and 2011.
RACE TO DEBASE
We additionally saw the Cartel’s debasement strategy unfold and tracked its coordinated responses.
THE ‘ORIGINAL SIN’
What we are now watching however, as part of our FLOWS work, is the shifting mechanics of the Carry Trade. The “Original Sin” of International finance is to always borrow in a currency that is devaluing and trending lower. Additionally, and less appreciated is to flow investments through the currency cross that gives the best differential change against the carry currency.
First, let’s talk about the sustainability of the current “Carry” in the Yen and then recent developments in what may be emerging as the new currency cross of choice. The current equity market melt-up is dependent on this for its sustainability in the near to intermediate term.
YEN CARRY IN PLACE FOR INTERMEDIATE TERM
The “Three Arrows” of ABE-nomics are not working and we can expect sustained and likely increased levels of BOJ Balance Sheet expansion.
Hugh Hendry made the headlines when he recently became a ‘tactical’ market bull. An excerpt from his report is quite telling:
CURRNCY CROSS – Short Term Shift
We showed above the tight correlation between the EURJPY and the S&P 500. What is now becoming more correlated is the GBPJPY!
Markets react to data. The U.K. is a small open economy. It has thrown the kitchen sink at growth and it may finally be beginning to be show some results. Remember when Carney took the helm of the BOE people were quite pessimistic, worried and then from there on things started to turn. So there was already a backlog obviously. Then the confidence boost given the forward guidance and the change of strategy helped.
What were the drivers behind that growth? The main ingredients for the growth that we’re seeing are the funding for lending that has really spurred the credit creation more than it has on the continent. The stabilization of the euro area as a whole has helped confidence. People don’t ask a lot about what’s happening there, which is a change. They ask more about Scotland than about the euro zone. It’s telling. Then the third thing, which is more structural, the U.K. labor market has operated in a strange way relative to previous cycles, a more continental way. So there’s been less firing given economic circumstances, which has meant that more people kept a job. Rates went down and that helped their disposable income stay stable or actually grow. That has helped consumption and get the economy going again. So there’s a combination of forces and the market has reacted to that. The market is likely not excessive. It’s taking the view that the BOE may be the first to hike in the cycle in late 2015 ahead of the Fed.
Bloomberg recently laid out the case that the British Pound may be set for gains versus Japanese Yen:
We expect increasing levels of BOJ Balance Sheet Expansion, a strengthening UK Sterling and a shift in the Carry Trade dynamics. This may be unsettling to the equity markets as the shift takes place but is likely to result in a continued melt-up of the markets in the Intermediate term.
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Gordon T Long
Gordon T Long is not a registered advisor and does not give investment advice. His comments are an expression of opinion only and should not be construed in any manner whatsoever as recommendations to buy or sell a stock, option, future, bond, commodity or any other financial instrument at any time. While he believes his statements to be true, they always depend on the reliability of his own credible sources. Of course, he recommends that you consult with a qualified investment advisor, one licensed by appropriate regulatory agencies in your legal jurisdiction, before making any investment decisions, and barring that you are encouraged to confirm the facts on your own before making important investment commitments.
© Copyright 2013 Gordon T Long. The information herein was obtained from sources which Mr. Long believes reliable, but he does not guarantee its accuracy. None of the information, advertisements, website links, or any opinions expressed constitutes a solicitation of the purchase or sale of any securities or commodities. Please note that Mr. Long may already have invested or may from time to time invest in securities that are recommended or otherwise covered on this website. Mr. Long does not intend to disclose the extent of any current holdings or future transactions with respect to any particular security. You should consider this possibility before investing in any security based upon statements and information contained in any report, post, comment or suggestions you receive from him.