Monday, January 25, 2010
Friday, January 22, 2010
Thursday, January 21, 2010
The E7 - China, India, Brazil, Russia, Mexico, Indonesia, Turkey
Sunday, January 17, 2010
A key reason for this decline in EUR demand could be associated with the greater sovereign risks in EU bond markets. Greece clearly is a poster child for greater risk differentiation but we are seeing greater spread differences all across Europe relative to Germany. The ECB has been tracking these developments, see vox.org piece, What explains the surge in euro-area sovereign spreads during the financial crisis of 2007-09 ( Maria Grazia Attinasi, Cristina Checherita, Christiane Nickel,).
They find that the international risk aversion may be the key explanation for the spread dispersion but the second most important variable is the fiscal position or risk within the sovereign. The greater differentiation in the market translate to less liquidity and a general aversion to the EMU which we have not seen in the US. Hence, there is less substitutability from dollars to EUR. Even with the US headways against the dollar, there could be a the makings of dollar rally if the confidence in sovereign risk further declines.
Now what makes a depression different than a recession is that depressions follow a period of wild credit excess, and when the bubble bursts and the wheels begin to move in reverse, we are in a depression. A recession is a correction in real GDP in the context of a secular expansion, which is what all prior nine of them were, back to 1945.
But this was not a mere blip in real GDP — it is a post-bubble credit collapse. This is not a garden-variety recession at all, which an economic downturn triggered by an inflation-fighting Fed and excessive manufacturing inventories. A depression is all about deflating asset values and contracting private sector credit. In a recession, monetary and fiscal policy works, even if the lags can be long. In a depression, they do not work. And this is what we see today.
Sunday, January 10, 2010
This has been a recurring topic with little progress in finding ways to address the problem. There still is no clear definition of what it means to say that a market is in a bubble. The US market has recovered handsomely since the lows in March. Is that a bubble. The move has been a clear extreme. The Chinese stock market has increased 90% since its lows, but it is still below former highs. Is that a bubble? Is housing in a region in a bubble? Can sectors of the financial markets be in a bubble?
His argument is simple. The Taylor rule is subject to estimation error, or put differently, it is subject to a range because the inflation expectations are not precise. Use a different inflation number and you will get a different equilibrium fed funds rate. The Fed did not get it wrong because there use of the Rule or the interpretations of the facts was different at the time. In real-time using the Fed forecasts for inflation, there was a policy that was supportive for the economy but was not excessively easy. You will have to look to other causes for the housing bubble which leads to the regulatory theory.
Of course, we had housing bubbles in other countries that had easy money but that evidence seems to be dismissed without careful inspection. We also have the fact that even Alan Greenspan was an advocate of adjustable rate mortgages which made sense for many buyers who wanted low monthly payments and expected that the low interest rte policy of the fed would continue for a long time. This is not a regulatory issue. of course lax regulation was a contributor, but could lax regulation explain a bubble in a tight money situation? The counter example suggest that money was a contributor. Given that the current chairman was actively involved with the decisions of the easy money period, it would seem natural that the first reaction would be that the fed did not get it wrong.
So why is this important for environment today? We may keep rates close to zero in an effort to get the economy back on track and stop the deflationary expectations in the market. This is the same rationale given for low rates in the last recession. I am not saying that low rates are not needed, but reviewing the chairman's thought process will tell us whether he is willing to hold rates lower for a longer time period. The answer seems to be that the error will not be with monetary policy that stays easy for an extended period of time. Keep money easy and work the regulation and supervision angle to solve any excesses in the economy.
One of the best researchers in the area of adaptive decision making and the the use of intuition is Gary Klein. He is not an academic but a consultant who has been on the front-lines of trying to make professionals better decision-makers. His work is powerful and important in any discussion of how real life decisions are and ought to be made. I was naturally interested when I saw that he had a new book published.
His new book, Streetlights and Shadows: Searching for the Keys to Adaptive Decision Making, may be the culmination of all of his thinking on the development of decision processes. It is not so much a theoretical piece then a response to all of the processes that have been tried to help make better decisions that may be wrong. He discusses ten claims on how to make better decision which he shows are either wrong or have some strong flaws. all of the claims make sense. All of the claims most would agree with, yet Klein suggests that many are wrong or need to be tempered.
The EUR and yen both saw increases in exposure but there is further diversification across currencies which is another continuing trend.
Thursday, January 7, 2010
So what should banks do? Exactly what they are doing. Hold a lot of cash. Be careful and increase transaction based business to boost profits. Play the yield curve which has gotten steeper and do not commitment to longer-term lending.
The result is tight credit for those who do not have other capital markets options.
Exporters are key to the any resurgence in the Japanese economy. The global economy is recovering and Japan does not want to be left behind because of an appreciating currency especially relative to China. Research, of course, states that the impact of price changes on export businesses is complex. The pass-through problem has to be looked at on a micro basis based on the competition of the products; nevertheless, the strong appreciation has hurt Japan. The size of the yen appreciation relative to other currencies suggest that talking down the yen will help.
The conclusion is that the environment is just not very good for a strong recovery. Every category looks like a problem.
Interest rates have nowhere to go but up.
Budget deficit getting worse with structural problems.
Misery index rising.
I could go on but you get the picture. There economy needs a game changer and there does not seem to be one. You have to be defensive in this environment and look elsewhere for opportunities then from being long stocks.
Sunday, January 3, 2010
"Morgan Stanley has knocked up some currency-intervention models to help guide you through the uncertainty.
These are based on the following four criteria:
(1) market mis-pricing of relative growth outlooks;
(2) significant deviation of the real exchange rate from historical trend;
(3) excessive market positioning;
(4) increased momentum in exchange rate moves."
What the dollar rally has done is take away a significant amount of the pressure for intervention. The currency markets now have a 5% cushion to retrace before central banks start to again have that nervous feeling that the dollar has moved too much. We have not explicitly followed this type of model, but we track many of the components that are used in the MS model.
We ask the following questions to measure the potential for intervention:
- What is the momentum or trend in rates? Strong directional moves will be the catalysts for action even though it is called "excessive volatility". Range-bound high volatility will not get the attention of central banks.
- What is the exchange rate direction central banks want?Excessive market positioning is code for carry or short-term capital flows. One way flows will more likely cause intervention by central banks. Carry will often push exchange rates in the direction that central banks do not want.
- Are there significant deviations from fair value? Significant deviations from real exchange rates especially if the exchange rate is overvalued is a reason for intervention.
Saturday, January 2, 2010
- Leverage will have a real economic impact. However, what drives institutions to take levered trades is less clear. Lack of regulation may be one part but not the whole story. Think of China where there is a strong state run system that is having a property and leverage boom. Leverage is a function of what abks perceive as the risks. The environment matters and if the government sends signals or behaves in a manner that suggests thatere is limited downside risk, more leverage will be taken on by the market.
- The shadow banking system and securitization is fundamental to the working of credit markets. Lending is not just a banking activity. Hence, regulation between banks and securities has to integrated.
- Just because something is securitized does not mean that it is a liquid security. Similarly, just because something has a triple-A rating does not mean that it is liquid.
- Liquidity spirals are a problem. Whenever there is a capital call in one market, there is the potential for a ripple effect into other markets. The raising of capital in one market will require the selling of more liquid securities.
- The selling of some securities will lead to more selling if there is a price effect. Feedback effects are real. Price pressure even temporary can lead to liquidity crises.
- Liquidity is related to the level of information that players have in the market. Less information means less liquidity.
- Skill effects the liquidity of securities. If the valuation of security requires skill, there will be less liquidity.
- Simple securities will always have more liquidity than complex securities.
- Complex securities will require a liquidity premium independent of its level of specialization. More specialized or customized securities require more liquidity.
- Confidence effects liquidity. If there are loses in a type of security, there will be a loss of confidence which will affect the willingness of investors to re-enter the market. Hence, there will be a loss of liquidity.
- More data and information on securities will increase the level of liquidity. Data is a public good that helps all market participants even though it may hurt profits for a given market maker.
- Liquidity will affect arbitrage opportunities. Arbitrage will not take place without a premium if there is a the perception that there is less liquidity in the market.