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Economics times forex cargo

Опубликовано в Forex central bank | Октябрь 2, 2012

economics times forex cargo

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Meanwhile, inflation continued to rise, with no signs of slowing. Thus, as I remarked the last time around, it was inevitable that Asian Central Banks would inevitably come to their senses. First of all, they realized that there was no free lunch, and that controlling their currencies would disable them from using traditional monetary policy tools to fight inflation.

Second, while they could do without currency appreciation, they realized that this would have to be tolerated if they wanted to continue attracting foreign investment. Third, it is inevitable that emerging market currencies will continue to rise over the long-term, in line with productivity gains. Finally, in accordance with the unofficial rules of the currency war , emerging market countries are competing not with industrialized countries, but with each other.

If all of their currencies rise in unison, export competitiveness is unaffected, inflation is tamed, and foreign capital remains abundant. In fact, it seems like investors are less interested in distinguishing between the different emerging market currencies of Asia, since at this point, all of them offer similar currency appreciation over the last six months, returns have converged and similar inflation-adjusted carry.

Thus, it stands to reason that as Asian Central Banks continue to tighten interest rates, their currencies will continue to rise together. As more and more Central Banks enter the war in the form of forex intervention and capital controls, however, they are inadvertently stoking the fires of price inflation.

They will all soon face a serious choice: either raise interest rates and cease trying to weaken their currencies or risk hyperinflation and concomitant economic instability. This dilemma is fairly basic: a Central Bank cannot simultaneously control its currency and conduct an independent monetary policy. For example, if it seeks to adjust interest rates to serve domestic economic goals, it must understand that this will have unavoidable implications for demand for its currency, and vice versa.

These days, that dilemma is becoming increasingly sharp. Inflation in many emerging markets is rising to dangerous levels, real interest rates or negative, and all the while, latent pressure continues to bubble under their currencies. While capital controls have forced a modest decline in the carry trade, the expectation is that an inevitable tightening of monetary policy will soon make it viable once again.

Due to the ongoing perception of currency wars, emerging market Central Banks are trying to hold out for as long as possible, lest they make themselves into sudden targets for carry traders and currency speculators. Some have already bitten the bullet. Brazil, for example, raised its benchmark Selic rate to China has embarked on a similar path , but from a lower base. The majority of countries remain in firm denial, however.

Last week, Turkey took the unbelievable step of lowering interest rates in a vain attempt to decrease pressure on the Lira. While they should be patted on the back for creativity, such Central Banks must understand that their efforts are probably doomed to fail over the long-term. This would alleviate some inflationary pressures without altering the competitive dynamics of national export sectors and negatively impacting economic growth.

For better or worse, emerging market governments have started to refocus the blame for the currency wars away from the US and towards China. Regardless of whether the US is at fault for its quantitative easing program, emerging markets compete with China — and its allegedly undervalued currency — in matters of trade. Pressuring China to allow the Yuan to appreciate, then, would ultimately go a lot further in ending the currency war and eliminating their predicament than screaming at the Fed for flooding the world with Dollars.

Due to a new President and shifting politics, Brazil is angling to force the issue. But this is a new era! These currencies — and their Central Banks — are being thrust into the spotlight as they join more established Latin American countries in the fight to contain currency appreciation.

The Argentinean Peso seems to be dragging the entire index down, having never recovered from the sovereign debt default in Stock market indices in the region are closing in on all-time highs, and bond prices have risen i. Perhaps this not for naught, as the region recorded economic growth of 5.

While Mexico has so far refrained from intervention, it recently negotiated an IMF credit line which it could potentially tap for the purpose of holding down the Peso. All together, the Central Bank reserves of the six currencies mentioned above rose On the one hand, the raising of reserve requirements will certainly make it difficult for domestic banks to short their own currencies.

In addition, some foreign speculators are getting spooked about all of the uncertainty and have moved to limit their exposure to Latin America. On the other hand, there is the possibility that legitimate institutional investors will also be scared away, which is problematic because Latin America remains reliant on foreign capital to fund its lavish fiscal spending and growing trade deficits.

The problem, ultimately, is that Latin American countries want to have their cake and eat it too. In short, the appreciation of Latin American currencies has largely mirrored fundamentals. Individually and as a group, their exchange rates are still well below the bubble levels of Most of the rise over the last two years has merely offset the precipitous declines that took place during the height of the credit crisis.

They have flooded the commodities producers with cash, while continuing to punish Mexico and Argentina over fiscal issues. Central Banks might manage to stall that appreciation in the short-term, but once they accept the inevitability of interest rate hikes as Brazil already has as the cure for inflation, the long-term upward path will be restored. There is too much unregulated capital in the world, particularly in developed countries.

These guys will find ways around various restrictions. In the last few months, however, emerging market currencies gave back some of their gains as the EU sovereign debt crisis flared up and the currency wars began to rage. Given that neither of these uncertainties is likely to be resolved anytime soon, could be a tumultuous year for emerging markets.

The J. Emerging markets took advantage of the surge in investor interest to issue record amount of local currency debt and through a plethora of massive stock IPOs. Still, the intractable rise in currency and asset prices was generally seen as an undesirable trend, and emerging markets took significant steps to counter it.

More than a dozen central banks have already intervened directly in currency markets in a bid to hold down their currencies. Alas, most of these inflows were probably justified by fundamentals, which means that they are more difficult to fight against than if they were merely the product of speculation. This means that in spite of impressive performance in , corporate profits are still rising faster than share prices.

In addition, yields on emerging market sovereign debt still exceed the yields on comparable debt for western countries, despite being lower risk in some ways. While most of these trends are expected to persist in , there is one overriding wild card. How emerging markets respond to this issue could determine whether emerging market currencies outperform again in or whether they sink back to more normal levels. Thanks to stimulative economic and fiscal policies, easy credit, and relatively loose monetary policies, emerging markets recorded phenomenal GDP growth in The downside has been inflation.

The actual rates are almost certainly higher. These countries, and a handful of others, are now in the awkward position of trying to control inflation without stimulating further currency appreciation. If they raise interest rates, economic growth and price growth will almost certainly moderate. By the same token,speculative hot money will probably continue to flow in. The upside is that real interest rates will turn negative, and their currencies will probably be depreciated by investors.

Most analysts expect emerging market central banks to gradually hike interest rates over the next couple years. For fear of stoking further speculation, however, policy will probably remain somewhat accommodative and will be accompanied by strict capital controls. Meanwhile, economic growth should begin to pick up in the industrialized world, accompanied by a similar tightening of monetary and fiscal policy. As a result, investors will be forced to decide whether risk-adjusted real returns in emerging markets are adequate, and if not, whether to reverse the flow of funds back into the industrialized word.

In short, the outlook for the Real in is incredibly uncertain. There are two somewhat contradictory trends that have played a role in driving the Real to its current level. The first is the resurgence of the carry trade, whereby investors shift capital from low-risk, low-yield investments to higher-yield, higher-risk alternatives. With interest rates that are among the highest in the world — and certainly the highest among stable currencies — Brazil has been one of the prime recipients of carry trade funds.

Moreover, the Central Bank might have no choice but to hike its benchmark Selic rate further over the next couple years. Inflation, at 5. According to futures prices, investors expect the bank to lift the Selic rate currently at When you factor in low rates in the rest of the world, this would lift the yield spread between the Brazilian Real and most other comparable currencies to astronomical levels. Alas, this first trend started to abate in the second half of , due primarily to the EU sovereign debt crisis.

To be sure, Brazil is still an emerging-market economy, and is still perceived as being fraught with risk. However, when you consider that certain commodities prices sugar, cotton are at record highs and that the Brazilian economy barely dipped during the credit crisis, there are certainly riskier locales to park capital. Besides, many investors have determined that the interest rate premium that they receive from investing in Brazil is more than enough to compensate them for any added risk.

All else being equal, then, the Brazilian Real would probably continue rising at a measured pace in As I said, however, all else is not equal, since Brazil has pledged to do everything in their power to hold down the Real. Rather than raise interest rates — which invites speculative capital inflows — the Bank will probably put pressure on the government to rein in spending and tighten access to credit.

Over the long-term, this should allow it to lower rates to more sustainable levels, and prevent an expensive Rea from eroding the competitiveness of its export sector before it is too late. Over the short-term, however, the immediate focus is to bring down inflation, most likely through rate hikes. In the midst of the currency war controversy, there is one emerging market country that continues to insist that its currency is undervalued: Russia.

In other words, that it remains weak is not due to investor oversight. Given that nearly every other emerging market currency is either closing in on or has already breached its pre-credit crisis level, there must be something holding down the Ruble. That something happens to be a sizable current account deficit. Unlike with other emerging markets, capital is actually flowing out of Russia. Next, the real returns of investing in Russia are currently negative.

This would seem to compare favorably with the 2. While Ruble-denominated bonds pay a higher interest rate 7. For that reason, Russian yields and credit default swap spreads which insure against default are much higher in Russia than in other BRIC countries. As a result, Bank Rossii finds itself in a somewhat unique position among Central Banks of having to try to prop up its currency. What do investors think? More importantly, however, is that inflation is brought under control.

Until that happens, the Ruble will remain the main standout in a sea of emerging market currencies that otherwise continues to outperform. While the last few weeks have seen a slight pullback, there is cause for cautious optimism in At this point, I think the rise in Asian currencies has become somewhat self-fulfilling. Basically, investors expect Asian currencies to rise, and the consequent anticipatory capital inflows cause them to actually rise, thereby reinforcing investor sentiment.

Personally, I think that kind of mentality should inspire caution in even the most bullish of investors. In addition, emerging markets in general, and Asia in particular, have always been vulnerable to sudden capital outflow caused by flareups in risk aversion. The former sparked fears of a worldwide economic slowdown, while the latter precipitated a decline in risk appetite. As a bona fide fundamental analyst, it pains me to say that emerging market Asian currencies can expect some modest appreciation over the next year, barring any serious changes to the EU fiscal and global economic situations.

It seems that capital will continue to pour into Asia, which — rather than fundamentals — will continue to dictate performance. Emerging market economies must be whining about their currencies for a good reason. Why else would they spend billions intervening in forex markets and risk provoking a global trade war? As it turns out, however, the rise in emerging market currencies has been greatly exaggerated.

Over the last twelve months, the Brazilian Real is flat against the Dollar. Not to mention that if you measure their returns against stronger currencies i. Perhaps that explains why so many analysts are still pretty bullish. Moreover, as emerging market Central Banks continue to hike interest rates, returns on investment and consequently, the attraction to investors will rise further.

In fact, if credit default swap spreads are any indication, the risk of default is perceived as being lowest in emerging market economies. That means that investors are being compensated for taking less risk with greater returns! Investors are already devising products to thwart the controls. So-called Global Bonds , for example, allow foreign investors to buy emerging market bonds without having to pay any special taxes, because they are settled in the home currency of the investor.

Besides, investors with a long-term horizon can take solace that such taxes will become insignificant when allocated over a number of years. There are, however, reasons to be cautious, In the short-term, bad news and flare-ups in risk aversion invariably hit emerging market assets hardest. Regardless of what information can be gleaned from credit default spreads, the majority of investors still associate the US with safety and emerging markets with volatility.

In China over the past decade economic growth was about 10 percent, while company earnings growth was only about 2 percent. Personally, I am slightly bullish with regard to emerging market currencies. The figures I quoted at the beginning of this post make it clear that we are not yet in bubble territory. In addition, even if fundamentals in emerging markets are not quite as strong as foreign investors would like to believe, they are certainly a lot stronger than in industrialized economies.

Despite reaching a temporary stalemate, the currency war rages on, and individual countries continue to debate whether they should enter or watch their currencies continue to appreciate. With most countries, the war cries are coming from the political establishment, who feel compelled to demonstrate to their constituents that they are diligently monitoring the currency war. This is largely the case in New Zealand, as Members of Parliament have argued forcefully in favor of intervention.

He has insisted correctly that the New Zealand is being driven up, so much as its currency counterparts — namely the US Dollar — are being driven downward, by forces completely disconnected from New Zealand and way beyond its control.

Thus, if New Zealand tried to intervene, it would quickly be overpowered perhaps deliberately! Ultimately, it would end up spending lots of money in vain, and the Kiwi would continue to appreciate. Bollard has pointed out that a stronger currency is not without its perks: such as lower relative prices for certain natural resources, such as oil. In addition, since New Zealand is largely a commodity economy, its producers are being compensated for an expensive currency in the form of higher prices for milk, wool, and other staple exports.

While its other manufacturing operations have been punished by the expensive Kiwi, its economy is still relatively robust. Thanks to a series of tax cuts and the lowest interest rates in New Zealand history, GDP is forecast to return to trend in and At the same time, New Zealand is not such an attractive target for speculators. In addition, while the Kiwi has appreciated against the US Dollar, it has fallen mightily against the Australian Dollar en route to a multi-year low.

Going forward, there is reason to believe that the New Zealand Dollar will continue to appreciate against the US Dollar as a result of QE2 and a general sense of pessimism towards the US. The same is true with regard to currencies that actively intervene to prevent their currencies from appreciating.

What a disconnect! In a word, everything. The economy is booming. The Central Bank has hiked its benchmark interest rate once already to 2. In addition. Meanwhile, the US Federal Reserve Bank is contemplating an expansion of its quantitative easing program , and other Central Banks may follow suit.

Under the now fading paradigm of risk aversion, concerns of economic decline in the industrialized world would have been accompanied by a sell-off in emerging markets and capital flight to safe havens. As evidenced by the spike in the Korean Won and other emerging market currencies, such is no longer the case. Of course, both currencies had been appreciating at a similar clip. Once the Bank of Japan intervened, however, the BOK had no choice bu to double-down on its own efforts. The Bank of Korea seems to appreciate that there is only so much it can do.

It is also not very effective, and the Korean Won has continued to rise. By not raising interest rates and trying to hold its currency down, it risks stoking inflation. Thus, it seems the Korean Won is destined to keep rising. It, too, is well below its peak, and there is scope for further appreciation. The BOK will continue to make token attempts at halting its rise, but at this point, the forces that is fighting against — bullish investors and other Central Banks — are too great.

Brazil is beating the drumbeat of war. The forex variety, that is. This threatens us because it takes away our competitiveness. Rather, it will do battle on behalf of its currency, the Real. According to Goldman Sachs, the Real is now the most overvalued major currency in the world. Its benchmark Selic rate is Even after controlling inflation, this is the highest among major currencies. With other companies rushing to follow suit with debt and equity offerings, cash will probably continue to pour in.

As I said at the beginning of this post, the Bank of Brazil has several tools up its sleeve. It is also proposing reverse currency swaps, which would serve a similar purpose. Alas, while the government of Brazil is certainly sincere in its intentions to hold down the Real, it lacks the wherewithal.

Even controlling for the difference in the size of their respective economies, Brazil has still been thoroughly outspent. In short, Brazil would be wise to avoid full-fledged engagement in currency war. Besides, the Real strength can better be seen in terms of weakness in the US Dollar and other G4 currencies. Perhaps, it can take solace in the fact that the Real is so overvalued that it would seem to have no place to go but down.

Anyone who had bought emerging market currency s at the peak of the credit crisis in would have earned double digit annualized returns in the two years that have passed since then. There are only a handful of exceptions to this rule, and the most prominent one that I can think of is the Hungarian Forint. These are the kinds of numbers one might associates with mortgage-backed securities and credit default swaps, not currencies!

So why is the Forint in the doghouse? Ironically, the answer is connected to mortgages. During the inflation of the housing bubble, Hungarians preferred to borrow in Swiss Francs, because interest rates were significantly lower than domestic Hungarian rates. Of that, 82 percent is in Swiss francs, according to central bank data. Given how much the Forint has fallen against the Franc, you can bet they are now.

It goes without saying that even under the best of circumstances, it would be difficult to find the wherewithal — let alone the motivation — to repay such a loan. When you throw an economic recession into the mix, the prospects for repayment become even more bleak. On Sept. Five days later, it sold 60 billion forint of three-month Treasury bills, 10 billion forint more than planned. It makes you wonder: if the Greek Drachma were still around, how closely would it resemble the Forint?

The long wait is over! The report contains a veritable treasure trove of data, perhaps enough to keep analysts busy until the next report is released in This reversal is probably attributable to the credit crisis, which drove and in fact, continues to drive investors out of emerging market currencies and back into safe haven currencies, namely the Dollar, Yen, and Pound. While emerging currencies as a group accounted for a smaller share of overall activity, certain individual currencies managed to increase their respective shares.

Still other currencies, such as the Indonesian Rupiah and Malaysian Ringgit, also managed impressive gains but account for such a small share of volume as to be insignificant when looking at the overall the picture. In addition, when you consider that the overall forex pie is also increasing, the nominal increase in volume for these small currencies was actually quite large.

The ongoing search for yield in all corners of the financial markets is likely to bring some of the more obscure currencies into the fold. Thin questions about less-familiar currencies such as the Ukrainian hryvnia and Romanian leu. Thin cautioned that interest in such currencies is still probably lower than in , for a good reason.

Of course there will be a handful of institutional and even retail investors that want to make long-term bets on these currencies. They tend to be more aware of the risk and less sensitive to the higher cost and lower convenience. The overwhelming majority of traders, however, churn their portfolios daily, if not hundreds of times per day. In short, the majors will account for the majority of trading volume for the foreseeable future, regardless of what happens to the Euro.

As liquidity rises and spreads decline, volume will increase, and their rising importance will become self-fulfilling. The recovery that emerging markets their economies and financial markets have staged since the lows of is impressive. Even compared to twelve months ago, in , the performance of emerging market currencies holds up well. In the year-to-date, however, most of these currencies have appreciated only slightly, thanks to a particularly weak month of August.

The MSCI emerging market stock index is currently down 2. You can see from the chart above that most emerging market currencies tend to track this index pretty closely, rising and falling on the same days as the index. Interestingly, emerging market stocks appear to be much more volatile than emerging market currencies.

You can also see that while the Malaysian RInggit has started to separate itself from the pack, the others have moved in lockstep with each other and are all about even for the year. On the surface, this disconnect between stocks and bonds would seem to be an anomaly, or even a contradiction.

After all, if investors are only lukewarm about emerging market currencies and stocks, what reason would there be for them to get so excited about bonds. If you drill a little deeper, however, it all starts to make sense. Due to a weak appetite for risk, has been a favorable year for bonds, at the expense of stocks. On the contrary, this same dynamic is playing out simultaneously in emerging markets. When it comes to debt, emerging markets have actually outperformed G7 debt, in spite of the current risk-averse climate.

In other words, why would you want to earn 2. In addition, when it comes to investing in debt, the lack of volatility in emerging market currencies can bee seen as a plus, since it prevents the interest rates from becoming diluted. Emerging markets are going to be some of the first to freeze up in a crisis. With the onset of the Eurozone sovereign debt crisis this year, volatility levels in forex as well as in other financial markets , surged to levels not seen since the height of the credit crisis.

While volatility has subsided slightly over the last few months, it still remains above its average for the year, and significantly above levels of the last five years. The spike in volatility was easy enough to understand.

Basically, the possibility of a default by a member of the EU or even worse, a breakup of the Euro created massive uncertainty in the markets, spurring the flow of capital from regions and assets perceived as risky to those perceived as safe havens. As you can see from the chart below, this trend has begun to reverse itself, but still remains prone to sudden spikes.

While the crisis in the EU seems to have temporarily settled, investors are attuned to the possibility that it could flare up again at any moment. A failed bond issue, a higher-than-forecast budget deficit, political stalemate, labor strikes — all signal a failure to resolve the crisis, and would surely trigger a renewed upswing in volatility and sell-off in risky assets. The same goes for unforeseen crises in other regions, affecting other currencies.

Who knows. Another might be that Swiss banking exposure to insolvent east European households causes another banking crisis. It will be months or years before these latent crises even begin to manifest themselves, let alone achieve some kind of resolution. Increased economic fluctuations increase uncertainty. Moreover, the Federal Reserve sets monetary policy to try to maintain full employment and price stability.

But a result of this decision is volatility in the value of the dollar in foreign exchange markets. From the standpoint of forex strategy, there are a couple of lessons that can be learned. First of all, the carry trade will remain underground until volatility returns to more attractive levels. Until then, the potential gains from earning a positive yield spread will be offset by the possibility of sudden, irascible currency depreciation.

Second, growth currencies — despite boasting strong fundamentals — will remain vulnerable to sudden declines. After a slight respite following the culmination of the Eurozone debt crisis, emerging markets financial markets are back to the their former selves, with stocks, bonds, and currencies all performing well.

The rally is being driven by two principal factors. First, investors came to the gradual realization that the trend towards risk aversion had reached extreme proportions. Given that the crisis in the EU has been fairly limited both in scope and extent at least so far , it made little sense to punish emerging markets. In this aspect, emerging market investments of all kinds are more attractive than their counterparts in the developed world.

The second source of momentum for the rally is a long-term shift in capital allocation. Across all sectors, money is pouring into emerging markets at an even faster pace than before the credit crisis. Advanced economies are seen expanding around 2. Emerging market investors share the confidence of foreign investors, and it seems the flow of funds will primarily be one-way. At this point, the only thing that could derail emerging markets is if investors get too ahead of themselves.

While no one is predicting a similar outcome this time around, I think prudence and caution are nonetheless advisable. Given that its performance closely tracks the Australian Dollar, meanwhile, why pay it any attention? To be sure, the new currencies from Down Under trade in virtual lockstep, having strayed by only a few cents in either direction from their trading mean over the last year.

Perhaps, there is something worth analyzing after all! According to most analysts, the sudden rise is largely a product of risk-appetite. Specifically, as the EU sovereign debt crisis stalls, investors are relaxing, and gradually moving capital back into growth currencies, like the New Zealand Dollar. In fact, the Kiwi recently rose to a one-month high on the same day that Spain successfully completed a bond auction. You can see from the chart below that they have largely tracked each other over the last 12 months.

This relationship seems to have intensified over the last few weeks, as the New Zealand Dollar sometimes takes its cues directly from releases of US economic data. However, New Zealand economic fundamentals are also playing a role, perhaps even the dominant role.

Analysts project that the benchmark rate will reach 3. Widening interest rate differentials, combined with the ongoing recovery in risk appetite, could turn the Kiwi into a popular carry trade currency. Given that the Central Bank of Australia is also projected to further hike rates, it seems the Aussie will join the Kiwi in its upward march, and that the two currencies will continue to trade in lockstep. Options traders might try to construct a low volatility strategy, such as a short straddle or selling covered calls against the pair.

For currency traders that prefer the Aussie, meanwhile, the New Zealand Dollar could serve as an attractive hedge. To be sure, EM stocks, bonds, and currencies all dipped slightly in May when the crisis reached fever pitch, but they have since recovered their losses and are once again en route to record highs.

In fact, investors are continuing to punish the Eurozone as well as a handful of other risky areas. Simply, the fiscal and economic condition of is stronger than in developing countries. Whereas previously crises were known to originate in developing countries and spread to industrialized countries, this latest series of crisis turned that notion on its head. The credit and housing crises were largely the product of speculation in the West, and the sovereign debt crisis originated in Europe.

Thus, the funds continue to pour in. This is frankly incredible when you consider that around half of the countries with the largest weightings in the index have experienced debt crises of varying severity over the last decade. As far as forex investors are concerned, the confidence in EM capital markets should also extend to currencies. The carry trade is heating up thanks to the cheap Euro , and will probably only expand as EM Central Banks move to raise interest rates to combat inflation, as alluded to above.

If the Eurozone debt crisis intensifies, then you can expect some kind of pull-back. As with recent retracements, however, it will be only temporary. Since this debt needs to be rolled over frequently, South Korea is especially vulnerable to liquidity crunches. It has already placed modest limits on speculative derivative transactions with the goal of limiting capital flight. It is pressing to renew currency swaps with the Fed and the Bank of Japan in order to increase the supply of alternative currency.

In addition, it has taken to intervening directly in currency markets by selling Billions of Dollars on the spot market. The authorities will try to prevent one-way currency moves. This would have a significant — and possibly prolonged — impact on the Korean won. How should one proceed? In any event, South Korea will host a meeting of the G20 this week, which should yield more clarity into what the rest of has in store for the Won.

Generally speaking, investors are bullish about Brazil. To put it mildly, investor sentiment surrounding the Real is slightly less rosy. There are a handful of issues. First is the technical concern that the Real simply rose too far, too fast. Investors are also nervous about the sovereign debt crisis in the EU, and are responding by temporarily moving funds back to safe haven currencies. To be fair, increased risk could be accompanied by increased returns. Even withstanding a poor performance by the Real, itself, the benchmark Brazilian Selic rate stands at a healthy 9.

On the flipside, inflation is also surging 5. From the standpoint of investors, this is not really a concern, since there is no intention of using invested capital for consumption purposes. In fact, it could even be seen as positive, insofar as it will force the Central Bank of Brazil to continue to be aggressive in conducting monetary policy.

There seems to be a slight dichotomy between the data and the markets. On the one hand, there is plenty for investors to be excited about when looking at Brazil. If interest rates continue to rise, and the debt crisis in Euro can achieve some kind of stopgap resolution, perhaps this will change.

Regardless of how it ultimately plays out, though, the bailout not too mention the concomitant crisis is shaping up to be THE big market mover of As investors reposition their chips, some early front-runners are emerging. It might surprise you that one such leader is the Japanese Yen. On the surface, the Japanese Yen would seem to be an excellent candidate for shorting, especially in the context of the the Greek fiscal crisis.

First of all, with confidence in the Euro flagging, the Yen and the Dollar gain luster as the only viable reserve currencies. Second, the current consensus is that the Euro bailout will fail, and as a result, risk tolerance is running low at the moment. Analysts have been quick to point out that the rest of Asia among other regions are on the other side of this trend.

China could be hit especially hard. Of course, if the plan turns out to be a success, than the opposite will probably obtain. The rally in emerging markets that I wrote about in April is showing no sign of abating. While no such index that I know of exists for emerging market currencies, one can be quite certain that at the very least, it too would also have returned to its pre-crisis level.

The Greek fiscal crisis, far from discouraging risk-averse investors from emerging markets, appears to instead be spurring them closer. From a comparative standpoint, emerging market governments are in much better shape than their industrialized counterparts, to say nothing of Greece.

Credit ratings on a handful of emerging market debt issues are gradually being raised, whereas Greece was downgraded to junk status. The real story here, however, is less the growing investor interest in emerging markets which is now well established , and more the growing ambivalence of emerging markets.

No doubt grateful to be attracting record sums of capital at lower-than-ever interest rates, emerging market governments are nonetheless unhappy about the resulting currency appreciation. Taiwan has emerged as the unlikely voice of emerging markets on this issue.

Last month, Poland intervened by selling the Zloty against the Dollar. The Central Bank of South Africa cut interest rates by 50 basis points in March, despite surging inflation. Brazil continues to hold auctions to buy Dollars on the spot market, while India mulls implementing some form of a Tobin tax on currency transactions. Not long ago, such measures would have been criticized as protectionist and against liberal, free-market principles.

Not anymore. In short, emerging markets have the green light to go ahead and stop their currencies from appreciating. But will they act on it? Still, we usually assume that with high return, comes high risk. How could it be that what are thought of as risky currencies are now less volatile than the so-called majors.

Does it really make sense, for example, that the Turkish Lira is less volatile than the British Pound. Without exploring this particular pair in detail, in a word, the answer is yes. In , emerging market growth is projected to be higher than in the industrialized world. Inflation is relatively stable, and debt levels are comparatively low. Investors are taking notice. Meanwhile, credit default swaps are pricing in a.

This year, the US is projected to spend more on servicing its debt than any other country except for the UK. What are the forex implications? For the first time, we could see the G4 currencies start trading as a bloc. The introduction of the Euro ten years ago only strengthened this trend, which is ironic considering the EU has also become an establishment currency.

Still, the concepts that will form the backbone of this post — volatility, risk, and carry — can be seen clearly through the prism of the Real. In forex markets, complacency towards risk has manifested itself in the form of decreasing volatility. When you look at the most commonly-traded currency pairs actually most currency pairs involving the 35 most popular currencies , volatility is increasing for only nine of them.

The fact that volatility is currently low suggests that the carry trade, for example, is set to become increasingly viable, especially when you factor in upcoming interest rate hikes. On the other hand, real interest rate differentials are currently modest from a historical standpoint , and the concern is that rate hikes could be accompanied by rising volatility.

You can cross-reference interest differentials with these charts — which uses recent mean return and volatility as the basis for forecasting confidence intervals — to get an idea about which pairs offer the best value i.

Just be aware that a sudden upswing in volatility could put a big dent in your risk-adjusted returns. One of the main themes even if not always overt of my posts recently has been the revival of the carry trade, if not the already extant revival than at least the imminent one. In this context, there is no better candidate than the Brazilian Real. After a stellar , the Brazilian Real opened in much the same way that most emerging market currencies did: down.

It is here where Brazil and the Real shines. The boom-and-bust and hyperinflation of previous decades has been replaced by steady growth. The country was one of the last major economies into recession, but one of the first out. Moreover, its economy is very well-balanced, and consumer debt levels are relatively low. Unlike in China, for example, infrastructure investment in Brazil still has plenty of room to grow, without crowding out private investment.

This is important, given that the World Cup and Olympics are right around the corner. Where does the carry trade fit into this? Impossibly, this represents a record low, despite the fact that this is nearly 8. And the Brazilian rate is only set to rise.

At the last meeting of the Bank of Brazil, 3 out of 8 Board members voted to hike the Selic rate by 50 basis points. Since then, inflation has continued to creep up and Mr. Meirelles has firmly renounced his political ambitions , and the stage is now set for a 75 basis point hike at the next meeting, to be held on April As long as Brazilian interest rates can keep up with inflation, then, it looks like the Real will end in much the same fashion as Since most emerging market economies and financial markets are fairly small, their currencies are subject to the whims of international investors, moreso than is the case with major currencies.

For that reason, when I research emerging market currencies as a whole, I often like to focus on what investors are saying are saying about their stocks and bonds. So popular, in fact, that even the most cautious of institutions have developed an appetite. For the most part, investors are still quite bullish on both stocks and bonds, despite — or perhaps because of — their amazing performances in Still, there is concern that since emerging market stocks and bonds are basically in line with fundamentals, a further inflow of capital would push them into bubble territory.

Some investors have started to talk about bubbles, but these appear to be more regional in nature, and the handful of bears point to specific countries rather than dismiss emerging markets outright. The South African Rand , meanwhile appears to be overvalued, but the Central Bank of South Africa has announced that it will allow the Rand to continue appreciating.

The Chilean Peso , meanwhile, is also poised to appreciate, ironically because of the recent earthquake, as Billions of Dollars aimed at relief efforts are already pouring into the country. While emerging market investors like to pretend that this is irrelevant, the fact is that they are still somewhat skittish, and even a minor crisis would send them running towards the exits.

While China, India, and to a lesser-extent, Brazil, all continue to outperform, Russia has begun to lag. If the acronym is to be preserved, the only choices are Romania or Rwanda. The Ruble fared equally poorly, relatively speaking. A similar picture can be painted with its.

The other half is as much cultural as structural. Corruption is rampant, and the bureaucracy is out of control. What about the Ruble, then? In the long-term, the Central Bank has pledged to shift its monetary policy away from micromanaging the Ruble. For the time being however, it remains focused on keeping the Ruble within a carefully prescribed range. On the surface, the Ruble would seem to represent an excellent candidate for the carry trade.

Moreover, the Central Bank has basically promised not to cut rates any further from the current record low. Even more remarkably, this is the lowest level in decades! In other words, there is no interest too be earned from a Ruble carry trade, and the only upside is the appreciation in the Ruble.

And that ignores the downside risks, which are significant. After Russia defaulted on its debt in , the international financial community basically lost confidence in the Ruble. In short, I see very little upside from investing in the Ruble. There is no money to be earned from a Ruble carry trade. Betting on the Russian economy seems misguided. Betting on a continued rise in oil and gas prices would be better achieved by buying oil and gas futures directly.

Meanwhile, any hiccup in the global economic recovery will certainly be met with an exodus of capital from Russia. Stick to the BIC countries instead. In , so-called commodity currencies — both individually and as a group — registered record-breaking gains. While the outlook for is slightly less rosy if only because of the law of averages , investors would still be wise to keep such currencies on their radar screen.

Strong commodity prices represent one such rationale. Commodity currencies — and commodities in general — have always held allure as investment vehicles because of their tangibility and necessity. Simply, modern economies depend on commodities for their functioning.

Thus, countries rich in natural resources would seem to represent safe bets, since they can be assured of demand both during periods of expansion and during economic downturns. The strong performance of commodity currencies in underscores this point, since despite the fact that prices for many commodities are well below the record highs of , these currencies are very close to their highs. More specifically, the Canadian Dollar often tracks the price of oil; this correlation will probably only strengthen when the oil sands of western Canada are developed.

While rich in many natural resources, it is gold that both Australia and South Africa are famous for, and to which their currencies are often tethered. Brazil and New Zealand deal in a more diverse array of commodities, and the Kiwi and Real often move in tandem with broad-based commodities indexes. There is also the Mexican Peso oil , the Russian Ruble natural gas , the Norwegian Krona oil , and Chilean Peso copper , but the correlations between these currencies and the respective commodities for which they are famous tend to be looser.

For commodity pure-plays, your best bet, then, would be to invest in the commodities themselves. At the time, I argued that the former category was comprised mainly of the Dollar and the Pound, with most other currencies healthy by comparison. While I still stand by this paradigm, I would like to revise it slightly. Specifically, I would like to add the Euro and the Yen to this list. In the interim, the country has suffered sub-par growth and routine recessions.

The fiscal problems of the US and UK governments as well as the debts of their citizens and companies have long been famous. Canada and the Loonie, by extension is also looking sickly, with its surging national debt and record budget deficits.

The only reason it is being spared from the list is because of its richness in natural resources; in other words, it has something tangible that it can use to pay its debts. There is also a correction that is taking place within the group of sick currencies. Volatility has surged to a 3-month high , and investors are responding by moving funds back to the US. What happened?! The Rand represents an interesting case study because it sits at the nexus of several trends. The first is the movement of funds into currencies with high interest rates.

The second is the movement of funds into economies that are rich in natural resources. The third is the movement of funds generally into emerging market economies. First of all, natural resource prices gold and platinum remain buoyant. Gold, as most of you are probably aware, is still hovering close to its nominal all-time high, while the price of platinum has resumed its upward trend, and is arguably closer to is all-time high than oil.

How about interest rates? Well, South African rates are among the highest in the world. Well, this too, looks shaky. In contrast to the modest contraction in that made it a standout, may not be so kind. The US economy is projected to grow by 2.

For those employing a carry trade strategy, the Rand is also not an attractive candidate, since the positive interest rate spread it enjoys small in real terms and shrinking is hardly enough to compensate for the risk of currency depreciation. In my opinion, this is a situation in which technical analysis — because of the potential to send conflicting signals — falls short.

The Korea Won has adhered closely to the overarching forex narrative. With the return of risk-taking in the second quarter of , however, the safe-haven appeal of the Dollar faded, and the Won rebounded strongly. With the potential end of the carry trade in sight, however, the Won has stuttered, and some analysts portend a decline in the near-term. Korean investments have certainly been buoyant of late, but not nearly to the same extent as in other emerging markets, where it could be argued speculative bubbles are now forming.

Instead, investors have been flocking to Korea for the economic fundamentals. In fact, the rising Won has has virtually no effect on exports, as Korean companies had prudently assumed that the Korean Won would be even more expensive based on levels. After a modest expansion in , GDP is projected to grow by 4. The Central Bank of Korea is also operating as though the Won will keep appreciating, irrespective of what happens to the carry trade.

With the recent expiration of a currency swap with the Fed, this is just as well, as Dollars could soon once again be in short supply. Korean monetary policy remains expansionary, but if the economy takes off in as expected, the Central Bank will have no choice but to raise rates and keep inflation within its target range. In addition, there is now talk of turning the Korean Won into an international currency. That the government of Korea is looking to promote the Won as a stable currency implies that it is comfortable with the prospect of further appreciation.

In short, the Won will probably be one of the standouts in Many currencies will suffer as changes in global monetary policy and the appearance of asset price bubbles cause investors to back off of the carry trade and exit certain emerging markets. On that note, happy new year! Many analysts are pointing to Friday, December 4, as the day that logic returned to the forex markets. On that day, the scheduled release of US non-farm payrolls indicated a drop in the unemployment rate and shocked investors.

This was noteworthy in and of itself because it suggests that the recession is already fading , but also because of the way it was digested by investors; for the first time in perhaps over a year, positive news was accompanied by a rise in the Dollar. HAL 1, Market Watch. Mutual Funds. ET NOW. Cryptocurrency By Crypto Influencers. Crypto Podcast. Crypto Meet. Crypto TV. Expert Speak. Stocks Dons of Dalal Street.

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