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Rising noise level on currency wars!

|Includes: SPY, iShares 20+ Year Treasury Bond ETF (TLT)
Such is the sad result of this last weekend's IMF meeting in Washington, which ended with no concrete proposal to strengthen international co-operation with respect to currencies. Instead the meeting resembled more a rehearsal of The Bald Soprano than a meeting of the planet's "decision-makers".
 
While the world awaits the Fed's decision on whether or not to launch a QE2, tensions are mounting between China and its trading partners as a result of its currency manipulation as the euro is climbs to levels inconsistent with the weakness of eurozone peripheral nations. In the meantime, Japan has returned to intervening to hold down its currency for the first time in six years and emerging countries are beginning to raise their voices, like Brazil, which just issued a warning against currency wars. All things said and done, I think we had every right to expect a bit more resolution from that summit!
 
I have thus taken a number of excerpts from the avalanche of contradictory statements made this weekend. Judge for yourself.
 
 
Currency war
 
 
Guido Mantega, Brazil Finance Minister:
 
He did it purposefully to "blow the whistle" on the "non-declared currency war," which many officials were trying to ignore.
"Each country is trying to undertake measures to devalue their currency," which is distorting a free-floating currency regime through "interventions that are explicit or implicit,"
 
 
Henrique Meirelles, Brazil CB:
 
“The reserve accumulation policy of emerging markets won’t take that responsibility, for an imbalance of exchange rates.”
The biggest imbalance today is the American monetary expansion, which is being used to fight lower growth and unemployment still high in the U.S. -- this is the biggest injection of liquidity in the international economy.”
 
 
Mme Lagarde, French Finance Minister:
 
A war, she said, would imply losers when in fact the goal is to have the largest number of winners within G-20 countries.
"I won't comment on foreign exchange," "I share my counterparts' impatience in finding a new system "I am convinced that it is not very useful to use warlike declarations, whether in foreign exchange or trade areas." In fact, "I don't think there is a war."
 
 
Yoshihiko Noda Japan Finance Minister:
 
 “I’m watching the markets carefully. There is no change in my stance that we will take bold actions, including intervention, if necessary.
 
 
Masaaki Shirakawa, BOJ:
 
Advanced economies need to keep monetary-easing policies in place for now to help spur global growth.”
“We need to continue with the unprecedented easy monetary policy, given the current economic conditions”
 
 
Li Daokui, PBOC:
 
 "Anxiety" in China about the idea of signing an international currency accord that would call for the strengthening of the Yuan, noting the economic difficulties the stronger yen caused Japan following its signing of the Plaza Accord in 1985. 
The government is trying to explain why "very rapid appreciation" would help neither China nor the U.S. But Beijing is still willing to see the currency rise.”
"I really, really hope that a new round of quantitative easing will help the American economyLet me put it in plain words: the new round of quantitative easing will create money supply in the U.S. economy, will create more investment in the U.S. economy, which in turn creates more employment in the U.S. economy which is in everybody's interest."
 
 
Trichet, ECB:
 
"We are very, very hostile to any kind of currency war"
"The U.S. authorities to my knowledge are in favor of a strong dollar. I always appreciate this reference. It means a strong dollar against other major floating currencies."
 
à Wishful thinking has never solved anything. When is the last time we have heard an American official praise the virtues of a strong dollar? Either he believes what he says, which is worrisome, or he assumes his listeners are babbling idiots, which is also a little worrying…
 
 
JC Juncker, Eurogroupe:
 
(He does) "not like the volatility currently surrounding the euro's exchange rate. So far the appreciation of the euro has not endangered the recovery. Too strong a euro, however, may perhaps not undermine but certainly hamper the recovery. But this level has not been reached yet."
Countries like Germany will find it easier to digest the rising exchange rates than weaker economies on the periphery, for which it "would certainly be more beneficial if the value of the euro would recede."
 
 
 
 
Focus on the ECB, which tightens the screws
 
 
In Europe, we were treated to a surprising and unusual slew of comments from ECB Council members, following the decision Sunday by eurozone national central banks (or NCBs) to harden access terms to refinancing liquidity operations for certain commercial banks that they deem too dependent on this type of financing.
I had to dig deeply into the technical jargon of the ECB/2010-13 orientation, by I found the passage in question in the appendices:
 
Paragraph 10. Section 2.4 is replaced by the following text:
"2.4. Suspension, limitation or exclusion on grounds of prudence or events of default.
In accordance with the provisions in the contractual or regulatory arrangements applied by the respective NCB (or by the ECB), the Eurosystem may suspend, limit or exclude counterparties’ access to monetary policy instruments on the grounds of prudence....
Finally, on the grounds of prudence, the Eurosystem may also reject assets, limit the use of assets or apply supplementary haircuts to assets submitted as collateral in Eurosystem credit operations by specific counterparties.
 
 
In other words, the ECB is trying encourage eurozone NCBs to take a more responsible position with respect to current monetary policy measures, which allow the zone's weakest commercial banks to borrow from the ECB via its refi operations without quantity limitations as long as the bring enough collateral.
National central banks can now differentiate access terms for specific counterparties.
 
  
And, yet, this is what ECB Vice President Mr Constancio has to say on the matter:
 
The ECB is analysing how to address the problem of banks still addicted to central bank liquidity but has no ready solution.
Asked whether the ECB is considering tailoring collateral rules to prevent certain banks from refinancing exclusively via the central bank:
"No, we don't have anything in mind right now."
 
And Mr Nowotny:  “Won't Vary Collateral Rules for Different Banks”.
 
Strange, isn't it?
 
If we take into account the supplementary restrictions announced in July by the ECB, with the significant increase in the amount of certain haircuts, which go into force 1 January, we can't help but wonder what is their true goal.
 
Aside from any moral judgement or interest as whether or not to prop up the weakest eurozone banks, which are also suffering from the depreciation of their stocks of peripheral nation sovereign debt, are we indeed witnessing a tightening of general monetary conditions, as the hike in the 3-month Euribor would seem to indicate?
 
Check out the graph below comparing this rate with the 3-month dollar Libor since 31 May 2010:
The hardening of monetary conditions on the eurozone is obvious, regardless of what the ECB says.
 
This also partially explains the 17% appreciation of the euro against the greenback, something we really need...like a hole a head!
 
Euribor 3-month and the 3-month dollar Libor
Flagrant divergence!
 
 
 But this has also been confirmed by certain statements made by ECB members (cited in these lines), although the consensus is not as obvious as it may appear at first glance.
 
 
Mr Stark:
ECB should start to consider rate rise. Fully aware of risks of too loose for too long monetary policy.”
"Inflation rates should remain moderate overall, but the risks to this outlook are slightly tilted to the upside."
 
 
Mr Nowotny:
"We have to be aware that the ECB doesn't have an exchange rate goal."
 
 
Mr Bini-Smaghi:
Liquidity Reduction Doesn't Mean ECB to TightenThere We don't see any inflation pressures in the euro area. So I don't think our policy should be based on a risk that we don't consider material at this stage."
"The exchange rate is one of the variables, like all the others that we take into account. It's part of the elements in formulating our monetary policy."
 
 
Mr Quaden:
"At the level of the Eurozone as a whole the domestic price pressures remain contained and the inflation expectations well anchored. And on that basis we think that our monetary policy stance, very accommodative, remains appropriate. And we don't see any deflationary risk in the Eurozone."
 
 
Mr Constancio:
Not Pre-committed To Unwind Special Measures in 2011. We will see in the first quarter."
(he does not) "comment on the level of the exchange rate at any moment. As you know, it is no direct objective of our policy. It is something that we take into consideration when we analyse future inflation prospects, but nothing else."
 
 
Good luck if you can find a consensus in all that…
 
 
Focus on Greece
 
The Greek debt situations seems to be shaping up in recent days. Are the Animals Spirits in the process of changing sides?
Some recent comments indeed point in the right direction.
 
 
Mr Mersch:
"It is definitely a legitimate question as to whether one should not give the fund the mandate to buy up government bonds."
(I support) "sticking to the fund for the long term," instead of letting it expire in 2013.
"In a currency union, in which there is no unified government, one definitely also needs an instrument for a crisis. Such a permanent mechanism would work "a little bit" like the IMF functions at the global level, but ideally the money from the rescue fund would not be needed.”
 
 
Mr Bini-Smaghi:
IMF Considers Extension of Greece's Loan Package. The IMF is certainly thinking of these issues. There are mechanisms in the IMF to prolong packages.”
“The International Monetary Fund may transform its loan to Greece into a longer-term repayment plan, a move that would allow the country to pay its loan back later without restructuring. There is a standard procedure which has been implemented many ways, in which the IMF transforms short-term programs to longer-term programs when it sees a country is on track”
 
 
 
 
PS: a little bonus for the US debate about price level targeting:
St. Louis Federal Reserve Bank Vice President William Gavin said Sunday that the U.S. economy "appears to be in a trap today" with short-term interest rates near their zero bound.
The veteran monetary economist, one of St. Louis Fed President James Bullard's advisors, said renewed Q.E. would only be successful to the extent that it affects inflationary expectations.
He maintained that the Fed would do better to make more of a commitment to a long-run inflation target -- or possibly a price level target.
The Fed is unlikely to get free of the dual mandate, he said, but if it had a stronger inflation target he said it would stand a better chance of avoiding the zero bound in the future.
Gavin said no central bank can hope to hit a short-run inflation target of, say 2%, each quarter, but said "that's not the same as saying you shouldn't be clear about where you want to go in the long run." With a price path or price level objective, he said that if prices rise too little or too much in one year, the Fed could make up for it the following year.
 
This is going to make itself felt in TIPS yields!
 
 
 
 
Asset allocation biases and advised option strategies. 
 
·        Bund, Bobl, Shatz: My conviction about the imminence of a QE2, which would push down interest rates, and a possible recourse to the ultimate weapon, Price Level Targeting, which would encourage a steepening of the yield curve in the US, seriously complicates matters.
Our bet on an easing of the situation in the peripheral eurozone nations, especially in Greece, is materialising but, surprising, is having little negative impact on German debt.
 
 
·        2800/2900 on the Eurostoxx 50.
We have even suggested and set up for certain clients 
call spreads and outright call purchases on the Eurostoxx on November and December, hoping for a little velocity, while benefiting from affordable implied volatility.
As valid as ever!
 
Feel free to contact me at any time for details on strikes and maturities.
 


Disclosure: Long 20 years OAT and 30 years BTP Zero Coupons, EDF Corp 5 Years 4.5%, Grece 2 Y and 10 Y bonds, Long Eurostoxx50 ETF