Monday, February 16, 2015

EURGRD The FX Pair Everyone Should be Talking About

As I write the powers that be in Brussels debate Europe's future and how Greece plays a role in it. There has never been a question in our mind as to whether or not Greece will leave the EU, it has always been a matter of when. Will that be today? We'll soon see. Either way its time for markets to start thinking about the implications on FX rates and specifically the soon to be reintroduced EURGRD rate.

On February 28, 2002 Greek Drachmas stopped trading in Greece and Euros took their place. The exchange rate at the time was EURGRD 340.750.

Depending on how they default on their debt obligations a rough guess would be the exchange rate reopens north of EURGRD 500.000. That number may seem a little scary and represents a large devaluation from when Greece entered the EU. An exchange rate of EURGRD 500.000 is less concerning than where it might be 30 days or 6 months from there. Will we see hyperinflation in Greece?

Hyperinflation in Drachmas is not new to Greece. Jim Grant does an excellent job sharing the history of Greek hyperinflation in his most recent article The Greek Monetary Back-Story. The history also helps to explain the understandably tense relationship between Greeks and Germans.

Greece's current finance minister Yanis Varoufakis is a fascinating character currently found at the heart of Greece's negotiations with the Troika. Considered an expert in game theory many believe Varoufakis to have a clever plan for leveraging Europe's desire to keep the EU and it's currency the Euro from falling apart, in favor of  Greece. After watching and reading interviews with Varoufakis we think that his approach is pretty direct and clear, even rational in many regards. Varoufakis knows Greece is drowning in debt and he is right to suggest that adding more will not solve the problem. Prime Minister Alexis Tsipras wrote a letter to the German tax payers saying exactly the same thing.

What doesn't square for us however is both Varoufakis and Tsipras's desire to implement socialist policies highly in favor of labor groups and their unions. This does not bode well for an economy that needs to foster mutual exchange and innovation. The end result in our opinion is further devaluation of Drachmas and a HUGE default on pension obligations. Labor unions, government employees and seniors will suffer the most which is tragic considering that they were the voters that brought Syriza to power.

For anyone wanting to take a deep dive into the problems that are currently impacting Greece and the EU I highly recommend Philipp Bagus's book The Tragedy of the Euro. The book is an enjoyable read and will clarify for any reader the exact reasons that the Euro will not stay intact.

Friday, February 6, 2015

Breaking the Hong Kong dollar

Hong Kong is an amazing place. It is a sophisticated country with well developed laws and markets that promote freedom and prosperity. It is consistently ranked as one of the easiest places in the world to do business. It is one of the most important financial centers in the world and its connection to China and proximity to other Asian nations position it well for the growing reemergence of Asia as the dominant global super power. With these positives in mind it is no surprise that billionaire investor Bill Ackman named the Hong Kong dollar as one of the most undervalued currencies in the world in 2011. While we have great respect for Mr. Ackman, he is not a global macro guy. When he made this call we had several investors calls asking us if we were putting on the same position. Our answer then was that no we weren't and if anything we would be taking the other side of his trade. There's a whole host of reasons why our research led us to feel this way. Here's just a few:

  • non-performing loans were growing in China
  • infrastructure investment as % of GDP was completely blown out of proportion
  • China's monetary base was being expanded at double the rate of the U.S.
  • shadow banking via commodity loans was (and still is) a giant fraud waiting to be exposed
  • ghost cities show that the construction boom has gone way too far
  • real food inflation exists which is entirely different from inflation from increased economic productivity
Let's now talk about the history of Hong Kong's currency peg and where we find ourselves today.

Hong Kong has had a peg to the dollar of 7.8 since 1983. The peg first started in 1972 at a rate of of 5.65. Between 1974 and 1983 the Hong Kong dollar floated meaning that markets would set the exchange rate. Singapore, who shares many similarities to Hong Kong, on the other hand has what they call a managed float. Singapore, rather than peg their currency to the dollar, or any other currency, monitors its trading within a floating band. When markets get volatile history has proven Singapore's monetary authority doesn't try to interfere much in protecting the band which is smart because it would be very expensive for them to do so.

Why is this all relevant? Over the last 15 years Hong Kong and Singapore have competed fiercely as Asian financial centers. Both do an excellent job and both have attracted enormous capital inflows from the region. If one country is doing good then the other one is doing good and vice versa. This means that comparing their currencies can give us early warning signs of cracks in the system. Comparing their currencies also lets visualize the potential pressure building on the Hong Kong dollar peg and gives an indication of which direction it may break.

In this chart you can see quite clearly that the U.S dollar is rising rapidly against the Singapore dollar. As I write USDSGD is trading around 1.35. It's kind of like visualizing the movement of tectonic plates below the surface before an earthquake is felt up above. We believe the USDSGD will cross 1.40 by the end of the year. Should things really accelerate towards 1.50 then we believe the Hong Kong dollar will break and the U.S. dollar will rapidly appreciate against it.

We believe that there are also other early warning signals we can watch to anticipate the break. With Hong Kong's intimate relationship to China it's valuable to understand the role of the yuan in China and in Hong Kong.

The Relationship Between CNY and CNH

It's not uncommon for investors (and politicians) in the western hemisphere to be confused by China's currency. Is it the renminmbi or the yuan? It doesn't help that there are 3 different currency abbreviations RMB, CNY, and CNH. Renminbi is simply the name of the currency whereas the yuan is the unit of account. An easy analogy that others have used is to think about Britain's currency which is called the sterling however Britain uses the pound as one of its units and the pound is what is most often referred to FX trading. So for trading purposes its best to start thinking in terms of yuans. 

Next becomes the question about CNY vs CNH. CNY is the onshore yuan market rate and CNH is the offshore yuan market rate. As you might guess with China's tight controls the onshore rate is more controlled than the offshore rate. While the offshore rate is a market rate it naturally tracks the onshore rate. Comparing the two can be quite useful. If CNH is at a premium to CNY it shows the markets expectations that the yuan will be fixed higher by the PBOC. If it is lower it shows that the market is anticipating yuan weakness. Now remember that since CNH and CNY are typically quoted as USDCNH and USDCNY a premium would be reflected as USDCNH trading below USDCNY i.e. it takes less offshore yuan to buy 1 dollar than onshore yuan.

In the chart below I have subtracted the offshore rate from the onshore rate. Anything below the line is showing weakness in the offshore market which could be an early sign that the onshore market may soon follow. Yuan weakness will mean Hong Kong dollar weakness.

While many people were caught off guard by the EURCHF peg being removed most believe it won't happen to USDHKD because its been there since 1983 whereas the EURCHF only lasted a few years.

We of course having predicted the EURCHF peg break from the day it was put on believe differently and this week apparently we are not the only ones as we noticed that one of our FX brokers, Saxo Bank raised currency margins to a whopping 20% on three currencies. Care to guess what those currencies are? They are HKD, CNY, and CNH. I would bet that Saxo Bank is looking at their client FX positions and realize that most clients holding those currencies are long rather than short and thus exposing Saxo to significant losses if there's a peg break. Smart move by Saxo and others will surely follow. Let's watch carefully this giant game of chicken that central bankers are playing and see who blinks next. Our bet? Clearly the Hong Kong Monetary Authority.

Thursday, February 5, 2015

Has Danish pension fund ATP lost their minds?

Bloomberg reporting today that Denmark's largest pension fund is not at all worried about the EURDKK peg breaking. Sigh, where to begin?

From the article:
“We have full confidence in the central bank’s ability to maintain the peg,” Carsten Stendevad, chief executive officer at ATP, said in an interview in Copenhagen. “The central bank has ample ammunition and we’re very comfortable with the situation.”
I suspect that what Stendevad says and believes are two entirely different things. With the Danish central bank lowering deposit rates again today down to -0.75% it shows that the peg is already under attack. And of course why wouldn't it be? This is a great trade and with minimal negative carry to put on.

In our opinion the central bank has two options right now; 1) drop the peg or 2) take rates drastically more negative as in double digit negative. If they think that 25bps adjustments and attempting flatten the yield curve by 
The fund, which oversees about $110 billion in assets, says it makes no financial sense to bet against Denmark’s currency regime, which has existed for three decades, has the full support of parliament and is backed by the European Central Bank.
Oh but it does make financial sense to bet against Denmark's currency regime! History proves this over and over again and the SNB's recent actions with EURCHF should have made these dangers quite evident to all central bankers and those that believe them.

I just can't get enough of this guys' quotes:
“The current situation in the market has not changed our firm conviction in the peg. The percentage of our assets in Danish kroner is lower today than at the end of the year and it was lower at the end of the year than it was a year ago,” Stendevad said. “I think that shows our full confidence and conviction that the peg is as safe as ever.”
My final comment - the peg is NOT "as safe as ever". Stay tuned.

Ukraine currency implosion

War destroys wealth. Here's a visual of Ukraine's currency tanking today. Any coincidence that Secretary Kerry arrived today?

And here's another fun currency chart. This is the Syrian pound tanking on May 13, 2013. That was a Monday for anyone checking their calendars. Any guess as to what happened Friday May 10, 2013? Secretary Kerry made news headlines when he said there was "strong evidence" Syria used chemical weapons. If anyone knows Secretary Kerry's travel schedule let me know so I can get some FX positions on accordingly.

Wednesday, February 4, 2015

Well that escalated quickly

For those that jumped on the bullish EURUSD freight train yesterday you better jump back off before it wrecks.

The ECB has announced today the removal of the credit rating waiver for Greek bonds.

Official announcement can be read here:

This is the ECB's way of playing hardball with Greece. To be clear there's no happy outcome for anyone at this point. Greece's new leadership is smart to reject being saddled with more debt. The ECB, like other central banks, has been running a giant ponzi scheme as it prints money to purchase ever more worthless debt instruments from undercapitalized banks in Europe.

Greece wants to reinstate pensions and benefits to workers. It amazes me that they could be so rational on one side of the equation i.e. moving towards defaulting on debt now that can never be paid back, while so irrational on the other side - making financial promises to the public they in no possible way can keep.

This is going to be an interesting battle between the Troika and Greece's new government. Several people have asked us what we predict the outcome will be. While we do have several predictions on specific outcomes I would say here it doesn't even matter. There is NO good outcome either way based on the parties calling the shots. Both sides lose in all options being put forth.

It's regrettable that this turmoil has to happen at all. Governments need to get out of markets and stop interfering with them in the first place. Greece simply has too much debt. This was the inevitable result of lax credit standards that appear everywhere in our current financial system.

Here's the problem with the modern banking system - its fraudulent. You cannot ever have a healthy financial system if you permit counterfeiting. If you deposit money in a bank and they are then able to create out of thin air credit equal to 90% of your deposit and lend it to someone who can spend it as freely in the economy as you can you will have massive distortions arise.

Why are we so afraid to hold banks and politicians accountable for what at the core is a simple crime? This is actually a crime in broad daylight and no one seems to be complaining. Protestors are angry and rightfully directing that anger at politicians and bankers however they don't understand the crime. They want more politicians to pass more regulations. We've been given Basel I, Basel II, and now Basel III as improved banking frameworks. For the average person this stuff is complicated, hell even for the advanced financial professional this stuff is complicated. At the end of the day though it all tries to treat symptoms rather than causes. Our financial system does not and will not work with fractional reserve banking. The remedy is simple 100% reserves against deposits. This doesn't mean that banks can't be in the lending business. Having banks intermediate lending between savers and borrowers can be a great thing. All that needs to be done is that instead of depositing money with the bank you lend the bank money in the form of a note just like they will turnaround and do with the borrower. Clean and simple and money doesn't get created out of thin air. Your money is available to the borrower but during the duration of the note it is not available to you. No duplication, no funny money. Simple right?

And before I finish this evenings rant I just got a notice from our bank in Cayman that any of our accounts denominated in Euros would be charged a rate of -0.40%. Yep negative deposit rates. That is what governments around the world are doing right now to screw you the saver. First they dilute your money by printing more of it and then they charge you a fee simply for trying to keep it safe.