China Moves Away From Currency Basket: What Does It Mean?

For one, this is a major shift in China's FX trading policy. They are officially moving to a market based policy of "managed flexibility."

Looking back at the massive moves in the global currency markets this week, we have to consider this Chinese decision as being one of the more relevant factors. The US Dollar Index traded up +3.4% on the week alone, closing at 75.85, catching plenty of global macro investors off guard. Asian currencies we’re under siege.

In plain English, this move by the Chinese is the 1st explicit one that moves them towards a free floating exchange rate. The announcement came on Wednesday, and that coincided with huge volatility in global currency trading immediately thereafter.

Since 2005, the Chinese used "reference currencies" as a basket. In addition to the US$, the major currencies in that basket were presumably the Euro, the Yen, and the South Korean won.

This important decision marks the third of consequence that the Chinese have made since 1997 on the FX front, where they went from a single regulated rate, to a managed floating rate relative to a "basket", to this most recent one.

It is global this time, indeed.
  • Wisdom Trees Chinese Yuan Fund (CYB) Is Breaking Down...
(chart courtesy of

TED Spread Continues To Signal That Cash Is King

The "TED" Spread is the difference between 3 month US Treasury Yields and 3 month LIBOR. I have attached the chart below to show the implied risks associated with recent spreads widening. Three month LIBOR closed at 2.80% on Friday. In addition to creating a widening TED spread, this is the highest it has traded over Fed funds since 1999.

Despite my being bullish on the US Market's immediate term "Trade", this remains one of the main reasons why I am negative on the intermediate "Trend". Credit risk remains a structural issue. Until this spread narrows again, investors, companies, and countries alike with the largest cash (liquidity) position will win this game of monopoly.

As the TED spread widens, the risk of defaults and bankruptcies continues to heighten. The global bankruptcy cycle is in its early stage.
Research Edge Chart by Andrew Barber, Director

US Market Performance: Week Ended 8/8/08...

Index Performance:

Week Ended 8/8/08:
Dow Jones +3.6%; SP500 +2.9%, Nasdaq +4.5%; Russell2000 +2.5%

2008 Year To Date:
Dow Jones (11.5%), SP500 (11.7%), Nasdaq (9.0%), Russell2000 (4.2%)

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The correlations are visually obvious but the chart still does not do justice to the magnitude of the statistical relationship between the price of crude oil and stocks, particularly the cruise lines. The R Square for cruise stocks (CCL, RCL) versus crude prices and the S&P versus crude is 79% and 49%, respectively. Thus, changes in crude explain almost 80% and 50% of the moves in cruise stocks and the S&P, respectively. Moreover, the relationships are highly significant with T Stats off the charts. Kudlow is right. It’s all about oil.

Taking the analysis one step further, changes in crude and the S&P combined explain 90% of the moves in cruise stocks. So to be a hot cruise stock picker all you need to know is where oil and the market are heading. Seems easy enough, right?

Trading cruise stocks right now is a tricky game for your typical consumer analyst. It’s probably wise to stay away, unless you are an oil trader in which case you might as well trade the commodity. Yields don’t seem to matter right now but they will. Yields have held up nicely but I have some serious doubts about sustainability, particularly in on-board spend. More on that later. For now, I’d be patient unless you’re willing to hedge out oil and the market.

Crude driving cruise stocks and the S&P

MCD – Currency Benefit Abating

MCD posted solid July comparable sales today. U.S. same-store sales grew 6.7% on top of a 4.3% increase last year. The question remains, however, how much of this top-line lift will be reflected in U.S. margins, which have declined for six consecutive quarters, as a result of the negative mix impact from customers trading down to the Dollar Menu and other lower priced menu offerings (average check at breakfast is lower than the rest of the day).

  • Currency Risk

    MCD’s July comparable sales were up 7.6% in Europe versus a 7.7% increase last year. MCD’s Europe division has posted consistently strong same-store sales results, which has translated to high operating income margins. Europe’s operating income growth, however, has been boosted by a growing foreign currency benefit for the last eight quarters. In 2Q, this currency impact helped by 16% in line with 1Q. As Keith McCullough highlighted earlier today, the U.S. Dollar Index is up 5% since July 14, which indicates the benefit MCD has seen from this currency cushion will begin to slow in the coming quarters. MCD’s Europe business has posted impressive operating growth in the double-digit range even excluding currency, but the incremental currency flow through has helped to offset U.S. margin weakness as it relates to the company’s consolidated operating income.


Personal consumption expenditures have been a rocket ship over the past 20 years. Gaming revenue growth has been even more impressive. Gambling spend accelerated from 0.3% of PCE in 1990 to a peak of 0.94% in December, 2006. The trend broke soon after that all the way down to 0.79% in June of 2008. As a point of reference, if gambling reverts to the mean since 1990 of 0.6%, revenues would fall by $20bn annually or 25% of the current level. This trend could be a double whammy in a consumer slowdown.

Gambling % of PCE rolling over

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