Conclusion: Asian currencies will continue to come under selling pressure vs. the USD due to broad-based monetary easing throughout the region over the next 3-6 months, as well as continued slowing in export demand. Positioning/concentration risk also remains a factor to the downside for Asian currencies as well.
Position: Short a Basket of Asian Currencies (AYT); Long the U.S. Dollar (UUP).
This morning, Keith added a short position in the Barclays GEMS Asia-8 ETN to our Virtual Portfolio. The thesis behind this positioning is one we’ve been hitting on for a couple of quarters now: Asian central banks will begin to ease monetary policy as our themes of Deflating the Inflation and Global Growth Slowing percolate into reported CPI and PPI data, in addition to stunting real GDP growth rates across the region.
To that point, even after last week’s +3.9% melt-up across in the CRB Index, this basket measurement of the commodity complex remains quantitatively bearish across our TREND and TAIL durations. Further strength in the U.S. Dollar Index, which has regained its TREND line (now support), is supportive of this trend. Not ironically, one of the factors in support of our King Dollar thesis is, in fact, a global monetary easing cycle being perpetuated by Asian, Latin American, and European central bank dovishness. Soros calls this self-reinforcing concept “reflexivity”; we call it “globally-interconnected risk”.
The Fed, having floored U.S. benchmark short-term interest rates near ZERO percent can’t cut any further and both reported inflation and inflation expectations will keep him from unleashing incremental QE into 2012. Meanwhile, on a relative basis rate-cutting out of these regions will continue to compress real interest rate differentials that have been largely supportive of their currencies relative to the USD since the March ’09 bottom. Asian rate markets – particularly short-term sovereign debt and interest rate swaps – continue to signal to us that our forecast remains the most probable of all potential scenarios.
Asia, which relies heavily on U.S. and E.U. capital and consumer demand to spur export growth may see their currencies experience incrementally less demand on the margin as growth continues to slow in these key economic blocs. Refer to our 10/25 report titled, “Global Growth Update: Incremental Deterioration Forthcoming?” for a more in-depth, quantitative analysis of this phenomenon and the recent trends therein.
Shifting gears a bit, the multi-factor, multi-duration dynamic analysis that continues to exert a game of tug-o-war on the global FX market is one that we would expect to continue at least over the intermediate term. In early 2009, investors could largely “set it and forget it” when it came to investing in Asian currencies via USD-denominated carry-trading strategies. Now, the breakout in cross-asset volatility in 2011 is creating a great deal of performance pressure in the FX fund universe:
- Three out of four of RBS’s various FX trading strategy indices are down in the YTD;
- As of last Friday, Deutsche Bank AG’s dollar-denominated Currency Returns Index has fallen -3.4% YTD – the largest decline since a 4% fall in 1991; and
- John Taylor, founder of FX Concepts LLC – the world’s largest currency hedge fund – is reported by Bloomberg to having been down -12% YTD as of Friday while AUM has fallen roughly -37.5% to $5 billion; “What’s really frustrating is that we’re supposed to do well in a lousy world market… We are doing badly,” he remarked in an Oct. 19 interview.
As always, the purpose of highlighting these data points is not to point fingers or humiliate anyone. Rather, we present them as opportunities to front-run incremental capital withdrawals from Asian countries as redemption requests mount. Just as concentration risk remains a critical risk to manage in the equity market, it has become increasingly so in the much-larger FX market given the one-sided trading patterns that have developed over the past few years of U.S. ZIRP.
Turing back to the AYT specifically, Indonesia has already begun its rate-cutting cycle and China, India, South Korea, Thailand, Philippines, and Malaysia have all recently signaled to the market that rate hikes are done and/or monetary easing is forthcoming. Taiwan, who reported overnight an annualized QoQ contraction of -1.1% in 3Q real GDP, took down both its 2011 and 2012 GDP forecasts by 20-30bps – paving the way for future rate cuts. Though not part of the AYT basket, the Monetary Authority of Singapore, which doesn’t use interest rates to dictate monetary policy, has already slowed appreciation of the Singapore dollar (SGD) alongside a downward revision to its 2011 and 2012 GDP forecasts.
All told, we continue to think King Dollar trends higher over the intermediate term and that the hollowed-out melt-up of last week did two things to the global currency market: a) its forced a lot of short-covering; and b) it created attractive entry points on the short-side for opportunistic funds. We’ve chosen to capitalize on this opportunity afforded by the latest round of Big Government Intervention by shorting the AYT in our Virtual Portfolio.
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Positions in Europe: Short EUR-USD (FXE)
Despite the significant bounce in European equity markets on 10/27 following announcements from the EU Summit, the market is increasingly (and again) pricing in downside as the “package” turned out to be more “trick” than “treat”, namely because the details on reinforcing the EFSF, the recapitalization of banks, and solutions for Greece’s persistent default issues were not provided.
One main cross-current that is developing is the dichotomy between Fitch ratings agency and ISDA on the implications of investors taking a “voluntary” haircut on their Greek holdings. ISDA’s letter of the law clearly states that so long as it’s a voluntary haircut, CDS will not be triggered to payout for default. However, Fitch clearly argues that a 50% reduction in debt payoff is default. This limbo leaves a lot of uncertainty for investors and should ultimately force the hand of Eurocrats to bring resolve to the issue. Should Eurocrats tip-toe around the issue (which is highly probable), expect investor appetite for European debt, particular for the periphery, to wane, which should put additional pressures on existing “temporary” facilities like the SMP to solve for demand of secondary sovereign issuance.
The outcome of this limbo would suggest we’re likely to see a new divergence that may drive swaps and yields in opposite directions at times, making yields the more appropriate risk benchmark. Here we’d point to Italy’s 10YR in particular, currently at 6.14%, and over the historically significant 6% that signaled a expeditious breakout line for Greece, Ireland, and Portugal requiring bailouts, as an important risk signal (see below).
European Sovereign CDS – European sovereign swaps tightened considerably last week on the heels of the Eurozone summit. French and German spreads tightened 10.6% and 8.5% respectively.
We remain short the EUR-USD via the etf FXE in the Hedgeye Virtual Portfolio. We’re still of the opinion that Europe’s road to a recovery is a long one, and ultimately growth expectations will have to come in lower as austerity erodes tax revenues, business and consumer confidence, and heightens joblessness. We think the EUR-USD cross is the relative loser over the near term as indecision on a policy to move the region beyond the sovereign and banking crisis persists and the ECB is more likely to cut its main rate over the intermediate term. We'd hope but don’t expect to see any clear smoke signals coming from this Thursday’s G20 meeting in Cannes on the aforementioned main topics of reinforcing the EFSF, bank recapitalizations or Greek haircuts. Expect rumors to float that the BRICs could ride in on a white horse.
European Financials CDS Monitor – Bank swaps were tighter in Europe last week for 38 of the 40 reference entities. The average tightening was 8.1% and the median tightening was 16.6%.
POSITIONS: Long Consumer Discretionary (XLY), Short Consumer Staples (XLP)
With my long-term TAIL line of resistance under assault this morning, what we’ve defined as TAIL Risk is right back on the table (defined as the proactively predictable). It’s just as powerful on the downside obviously as it is on the upside, so watch my TAIL line very closely.
- Immediate-term TRADE overbought = 1294
- TAIL = 1267
- Immediate-term TRADE oversold = 1247
The TAIL (1267) is sandwiched in between 1247 and 1294, so this is a very difficult spot to deal with – particularly with the immediate-term factoring of month-end markups. In the next 72 hours, this market could go either way and I wouldn’t be surprised. So I’m happy with letting the market tell me what to do next.
From the longest of long-term perspectives, all the US stock market is doing is making a series of lower-long-term highs (at 1267 we’re still -19.0% from the 2007 highs and -7.0% from the lower-long-term high established in April of 2011), so long-term investors should just keep that in mind.
Since I score my model on a 3-factor basis, what’s critical to acknowledge is that last week’s up move was not confirmed by either long-term VOLUME or VOLATILITY signals.
For now, long-term volatility and structurally impaired volume (inflows) looks like it’s here to stay.
Keith R. McCullough
Chief Executive Officer
THE HEDGEYE BREAKFAST MONITOR
Gasoline prices are down 50 bps over the last week but seem to be trending flat-to-slightly-higher as the dollar has weakened. Gas prices coming down from the 2Q high’s has been a tailwind for restaurant traffic.
The Nation’s Restaurant News Restaurant Social Media Index (RSMI) was released, ranking restaurant chains using three primary aspects of tracking in social media: digital brand interaction; consumer sentiment and social audience growth; and overall Klout score. Unsurprisingly, Starbucks topped the list. More surprising was Chili’s coming in at 75th. You can find the full list here.
YUM: Yum! Brands’ KFC raised its menu prices in China by 0.5-to-2 Yuan, according to media reports. The move is the third price adjustment that KFC China has made in 2011.
JACK, JMBA: Jack in the Box and Jamba Juice are testing Google Wallet in a limited trial of the technology that lets customers pay for purchases and redeem coupons with their smartphones, executives at each chain have said, according to Nation’s Restaurant News.
SONC: Sonic is putting out a new Bacon Cheddar Melt burger and a Mushroom Swiss Melt burger. The advertisement reads "starting at $1.99" but it is unclear what exactly that means. The burgers are served on "Texas toast".
MRT: Morton’s Restaurant Group was reiterated “Perform” at Oppenheimer.