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Zhong Jin's  Instablog

Zhong Jin
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I am an economic researcher with a focus on macroeconomic trends and financial markets.
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  • How Much Treasury will Fed Buy and Where will US Dollar Go?

    Major economies finally began the competitive devaluation process. The last time that Japan authority sold the huge amount of JPY in the market is January 9, 2004, when JPY 1.66 trillion was sold against USD in one day. At that day, USDJPY only rose by 0.4%, compared to 2.8% this time.  In March 2004, Japan government again sold more than 1 trillion of JPY in the currency market. After two BOJ interventions, USDJPY increased by nearly 10% to the 114 level in the mid-2004. However, by the end of 2004, USDJPY dropped back to the pre-intervention price level.


    When Japan engaged in the currency intervention activity in 2004, other major economies such as the U.S., EU, Australia, and UK all kept interest rates unchanged or even raised interest rates during that time period. It was then (2005) that JPY began to depreciate against every other major currency (remember carry trade?) till the beginning of the recession.


    History will not repeat this time, however. Right now, only two major developed economies have raised their interest rates so far, Canada and Australia. Most other developed economies are not going to remove their super-stimulated monetary policies in the rest of 2010. In the U.S., Goldman Sachs even suggests that Fed is going to spend $1 trillion on the Treasury in November as another QE action.   


    What does USDJPY movement have anything to do with commodity currencies? Under the current circumstance, only commodity economies have the room to raise interest rate again in the next 3 to 6 months.  Especially regarding AUD, on September 16, 2010, the Assistant Governor of RBA Philip Lowe said in his speech that


    “…given that there is currently a relatively limited amount of spare capacity in the economy, the risk of upwards pressure on inflation would be increased if investment and consumption were both to increase very strongly over the next few years.”


    Given the strong employment growth in Australia in August, investors should seriously consider the possibility that RBA raises interest rate again at the next policy meeting.      


    The most important event next week probably will be FOMC rate decision. Interest rate will not be changed, as everybody already knows.  The question is whether Fed will begin the Treasury purchasing program in the next meeting.  If so, what is the size of the program? As the chairman of Fed Bernanke said on August 27, 2010,


    “…To date, we have realized about $140 billion of repayments of principal on our holdings of agency debt and MBS…” 


    “…we estimated that an additional $400 billion or so of MBS and agency debt currently in the Fed's portfolio could be repaid by the end of 2011.”


    Since FOMC already announced that Fed would keep its balance sheet size constant by purchasing Treasury using the repayment of its holdings of MBS and agency debts. We expect that the program size should be no less than $500 billion, which will nearly double the current Fed’s holding ($784 billion as of August 25, 2010) of Treasury.  Under this scenario, by the end of 2011, Fed will hold close to 10% of the U.S. total national debt.  If we only count Treasury note and bond as “longer term Treasury securities” referred in August FOMC meeting statement, then Fed will hold close to 20% of the total Treasury notes and bonds by the end of 2011. 


    If as Goldman Sachs predicted, Fed decides to establish a $1 trillion Treasury purchasing program, more than 40% of longer term Treasury securities will be in Fed’s hand after 2011.  This surely is going to be a very bold move, comparable to the MBS purchasing program that Fed implemented during the worst day in crisis. Goldman Sachs must see a much more depressed picture in two months than today to make this call. 

    Sep 19 9:10 PM | Link | Comment!
  • Everything is About Job: Sino-US Trade Dispute and Commodity Currency ETFs

    In the last two weeks, employment data in several economies takes a turn for the better. Although overall nonfarm employment In U.S. in August decreases from July, it drops less than expected.  On September 9, 2010, initial unemployment claim also drops to the lowest level in two months. These improvements provide strong supports to stock markets. Commodity exporting countries are even better.  Canada also has enjoyed a strong employment growth, 35,800 from July to August, which is higher than expected. Australia employment change in August is not only positive (30,900 jobs), but also better than expected.


    Central banks in the commodity economies gave been normalizing their interest rates since the beginning of 2010.  On September 7, 2010, the Reserve Bank of Australia decides to keep the interest rate unchanged at 4.5%. Bank of Canada raises its interest rate to 1% from 0.75% on Wednesday. The central bank keeps its inflation outlook but again adjust the economic growth projection lower from its July Monetary Policy Report (NYSE:MPR). Its July MPR has already cut its projection on Canada’s economic growth rate from its April MPR. 


    However, other developed economies still keep their extremely low interest rates in place.  Many of them are talking about a second stimulus plan. When most major economies join in the depreciation effort, assets that are perceived to be able to preserve value will benefit.  Last time (2002) when the U.S. engaged in a currency devaluation campaign, commodities experienced a long booming period.  


    The joint devaluation of all major currencies usually leads to spiking commodity prices. Take a look at the commodity prices index compiled by the Reserve Bank of Australia.  RBA commodity prices index is a weighted average of recent changes in commodity prices.  It shows that the increase in commodity prices is at all time high right now, even higher than the 2008 bubble period.  This largely confirms that the stimulus policies taken by major economies in 2008 and 2009 help support commodity prices and avoid the deflation.




    (from RBA website)

    Going forward, with significant output gap and high unemployment problem existing in almost every economy, the inflation risks are limited by the shrinking global demand. Given the context of the slowing global economic recovery, we expect that commodity prices and commodity currencies have less likely to spike like 2008 in the rest of the 2010.  Gold is an exception because A) gold is perceived to preserve the value; B) gold price has little impact on real economy. That is also why we believe that “the gold bubble” is not going to burst anytime soon.


    Trade dispute between China and the U.S. is going to profoundly change the outlook of commodity currencies. The midterm election season officially begins after the Labor Day. Economy is the theme of this election.  Without realistic and politically acceptable options to quickly improve employment situation in the U.S., both parties are going to take the path of least resistance: blaming foreigners, in this case, Chinese. This week, as the latest case, the UAW publicizes its plan to sue China over clean energy exports.


    Although the trade tension has been a well known risk factor in the financial market, so far asset prices have not taken this factor seriously. Perhaps lack of action in the U.S. congress is the major reason. Now it is about to change. Next week, the House Ways and Mean Committee, the panel responsible for initially approving the proposed legislation, is going to hold a hearing on China’s trade and currency policies. The Senate Banking Committee is also scheduled to hold a hearing on the issue. With the election in sight and their careers at stake, those U.S. senators and congressmen are expected to move forward with tariff bills aimed at China in the next two months.


    China’s Yuan is going to appreciate as a short term response.  Back in April, when the U.S. was about to name China as the currency manipulator, China agreed to make Yuan more flexible. The result is that Yuan has appreciated by about 1% since then.  However, given that production costs in China continue to rise and Beijing seems to be determined to curb property prices, China does not have much room to appreciate.  We do not see how China can satisfy the U.S. demand.  The best scenario is that both sides reach an unhappy compromise and avoid an all-out trade war. 


    How do we trade commodity currency ETFs given such complications?


    FXC (ETF for CADUSD) is supported by several factors.    Better than expected economic data offer investors confidence in Canada economy right now, despite some sign of weakness in its housing sector.  Risk appetite is still the main driver for USDCAD. After the huge decline of the stock market in August, “risk on” mode has been back in the market so far.  The market will closely watch the retail sale and consumer confidence data, which are important leading indicators of the U.S. economy. Also the future trade dispute between China and the U.S. will benefit Canada since Canada is a major exporter to the U.S., competing with China.


    With the positive economic news coming out from Australia and China, FXA (ETF for AUDUSD) is strongly supported by fundamental data.  However, AUDUSD is at its four months high.  In my opinion, the risk of Sino-U.S. trade friction has not been correctly factored in the price yet. If the tone of the House Ways and Mean Committee hearing is harsh and determined next week, it may well reverse the upward direction of FXA.  

    Disclosure: No position
    Sep 12 10:07 PM | Link | Comment!
  • Fed Rate Decision and Its Impact on Stock Markets
    FOMC just ended its meeting on interest rate. Not surprisingly, the Fed rate is kept at 0.25%, given the recent wave of bad news on housing, retail, and employment. What does Fed have to say this time? In the FOMC statement from the April meeting, it said “…Growth in household spending has picked up recently…Housing starts have edged up…”.   It is no longer the case.  Since Fed had already have an extremely low interest rate, the main question before the meeting is what they can do to fuel the recovery. They just ended the asset purchasing program back in March. If they ever re-start the programs, it will send a powerful negative signal to markets that how bad things are and they are worried. And actually, the credit markets do not need more liquidity now, unlike September 2008. 
    The latest statement acknowledged the weakness in the housing market and retail, but reiterate Fed’s belief of “a gradual return to higher levels of resource utilization in a context of price stability”. Thomas M. Hoenig is again the only member voting against the low interest rate. Overall, this statement is very moderate. It is very modest and gives out nothing unexpected. Basically it means that Fed is now taking a “wait and see” attitude. This hand-off approach should have little impact on stock markets. 

    Disclosure: neutral
    Tags: FED
    Jun 23 2:28 PM | Link | Comment!
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