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The answer to "What's going to give the Fear Index a boost ?" was staring us in the face all along .... The threat of Thermonuclear War,...

August 11, 2017

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Only half-right means WRONG ..... but hey, these things happen so what's the next trade ?

March 11, 2019

 

ref :- "Goldman Cops to Misstep on Dollar Call, Eyes Yen Trade Instead" , Bloomberg Markets

 

So what ? Nobody gets every trading decision right and it's not as though we're unsympathetic but describing Goldman Sachs Group's rationale behind their recent "Short US dollar" trade as "half-right" is a pretty generous way of looking at it. In a note late on Friday Goldman pointed out that they had been stopped out of the trade the previous day  --  in other words, the market had moved against them to the point where their stop-loss order was activated, jettisoning the trade at a loss before it grew any larger.

 

Goldman's call to sell the Dollar Index (DXY) came in early January, immediately after a speech by US Fed Chairman Jay Powell in which they felt he was signalling a shift to a more cautious, wait-and-see monetary policy that would weigh on the US currency. They were absolutely right in their reading of the Fed's adjusted stance on policy, but wrong on how the dollar might behave on the back of it (it has strengthened, of course). The problem was that a major part of the Fed's thinking revolved around economic headwinds originating from outside of the United States. The policy steps that central banks in other nations are taking to tackle their own problems  --  more acute than those of the US  --  have meant that the Dollar has appreciated against their currencies despite the more dovish outlook from the Fed.

 

In particular, Europe has been at heart of the Dollar's strength. The Dollar Index has a 58% weighting to the US unit's value against the Euro, and Europe's economic forecasts are faltering. The ECB has lowered its estimate of growth in the Eurozone to 1.3% in 2019 when it was looking for 1.9% as recently as November. Even Germany, particularly affected by motor industry trade concerns, is stumbling and there are a raft of political issues to be tackled (Brexit, Italy, Spain).  The ECB has responded by postponing any thought of lifting rates from zero (and below) or of starting to reduce its balance sheet (a.k.a. quantitative tightening). In effect, the Fed may have turned a little more dovish but others are more dovish still.

 

Goldman say that in hindsight they'd have been wiser to trade their reading of Fed intentions by buying interest rate contracts (where prices rise as rates/yields fall) rather than selling the Dollar .... to which we can only say "quite so".

 

Anyway, mark that trade down as one that got away and move on to the next one .... which for Goldman is a more specific call to sell the dollar , this time against the Japanese Yen. Whenever someone tells you to buy the Yen, you can bet that one or both of two favourite factors is playing a major role. The first is that Japan's key interest rates and yields are so low (and have been for 20 years) that adverse interest rate differentials are no longer relevant. The second and more crucial reason is that the Yen, like the Swissie, is a SAFE HAVEN.

 

It's probably worth reminding ourselves about what makes a currency a safe haven. Generally speaking, one would look out for : decent growth, strong national finances, a stable political system and good liquidity (the ability to be bought and sold easily). The Yen is slightly odd in that whilst it can tick off the last two of those requirements, nobody would suggest that Japan could claim either respectable growth or strong finances  --  years of trying to stimulate the economy have left the country with a massive debt- to- GDP ratio, and the central bank with a balance sheet larger than its GDP.

 

But ....

 

Two factors work hugely in the Yen's favour when assessing its safe-haven credentials. As a vast exporting nation, Japan runs a current account surplus to match, which is invested in overseas assets. In times of strife, these assets can be liquidated and the funds repatriated back home to Japan, pushing up the value of the Yen. Beyond that, the Yen is the currency market's foremost funding currency for the "carry trade".

 

*** Brief reminder of the carry trade : borrow in a low-interest rate currency (i.e. the Yen), sell the Yen against a higher interest rate currency to take advantage of the bigger returns ***

 

Carry trades are just dandy ..... until investors get nervous and of a "risk-off" frame of mind. Then the carry trades (and their short yen positions) are reversed, pumping up the value of the Japanese unit.

 

Even if you don't agree with Goldman's conclusion, it would be hard to argue with a view that right now we are never very far away from a risk-off scenario. Goldman suggests selling USD / JPY (last at JY111.20) with a target of JY108.00. It's a perfectly reasonable argument ..... trouble is, if the Yen comes back in demand as a safe haven, what will that mean for other asset classes ? 

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