A View from the Trenches, March 2nd, 2010: "Quietly leaving the Euro"
Please, click here to read this article in pdf format: march-2-2010
We will be brief today, for nothing of macroeconomic consequence has
taken place in the past 24hrs. The action that caught our attention
yesterday was in the foreign exchange market (the market that never
lies). In particular, we refer to the action in the Canadian dollar.
The cross with the Euro gained (i.e. the CAD rose against the Euro) 2.3
cents intraday, and although (or because) the TSX composite closed
+0.85% higher, we can only deduct that the demand for Canadian dollars
did not reflect a pari-passu demand for Canadian assets. Therefore, our
intuition is that with yesterday’s calm, the demand for Canadian
dollars that did not end in assets was a demand for reserve purposes,
at a central bank. We are open to alternative suggestions to explain
this phenomenon but any of these explanations would also have to
address how the Canadian dollar did so perform on a day where neither
oil nor gold rallied.
Was the CAD rally based on the news that the Canadian economy
expanded at a 5% annualized rate in the fourth quarter (faster than
forecasted by the Bank of Canada)? We doubt it because a) the CAD’s
sensitivity to interest rate gap (i.e. with the higher than expected
growth rate the market revises its forecast on policy rates) has been
low, and b) the strength was not uniform but clearly against the Euro.
On another note, in an interesting report, Bank of America estimated
yesterday that approximately $160BN will flow to private investors by
the end of 2010, as a result of the buyout of delinquent mortgage loans
by Fannie Mae and Freddie Mac (refer: “The long and short of
delinquency buyouts”, in Situation Room, Bank of America Merrill Lynch Credit Strategy, March 1, 2010). At “A View from the Trenches” we had anticipated the consequences of this operation back on January 4th, when we wrote:
“ …Since (our) last letter of 2009, the US Treasury announced it
would lift the cap on the Preferred Stock Purchase Program (refer
Michael Cloherty’s “Removing the PSPP ceiling: Treasury’s unlimited
support”, Bank of America’ “US Agencies” report of Dec 29/09). This
explicit show of support for agency debt (which I assumed it was going
to smoothly disappear in 2010) tells (us) that the USD strength will be
only a relative notion in 2010. (We) say relative because the strength
should show vs. those countries that explicitly decide to import USD
inflation (i.e. Brazil) or face serious fiscal problems (i.e. Euro
zone), while the weakness should show vs. those countries that will
profit from the credit-inflated recovery (Emerging markets or commodity
currencies, like the CAD)… “
We stand by these comments and the market is proving us right. What
we did not grasp back then was the magnitude of this operation ($160BN
of private liquidity) under certain loan delinquency level assumptions
that can further deteriorate, if the recovery process disappoints. We
invite readers to closely monitor activity in the GSE market for this
is serious enough to keep the dream of asset inflation alive.
(Note: Mainstream economists use the term “asset inflation” to refer
to bubbles, because their theory of inflation is wrongfully based on
the non-neutrality of money, as implied by the exchange equation: M*V =
P*Q. Therefore, they treat bubbles as an aberration that can only be
addressed with regulation)
Martin Sibileau
The comments expressed in this
website and daily letters are my own personal opinions only and do not
necessarily reflect the positions or opinions of my employer or its
affiliates. All comments are based upon my current knowledge and my own
personal experiences. You should conduct independent research to verify
the validity of any statements made in this website before basing any
decisions upon those statements. In addition, any views or opinions
expressed by visitors to this website are theirs and do not necessarily
reflect mine. My comments provide general information only. Neither the
information nor any opinion expressed constitutes a solicitation, an
offer or an invitation to make an offer, to buy or sell any securities
or other financial instrument or any derivative related to such
securities or instruments (e.g., options, futures, warrants, and
contracts for differences). My comments are not intended to provide
personal investment advice and they do not take into account the
specific investment objectives, financial situation and the particular
needs of any specific person.