Newsletter: A Sideways Look At the Market w/c 29th September 2008
As markets around the world lurch from crisis to drama and back again we are still waiting the outcome (if any) of the Paulson plan to save the US banking system and economy thereby avoiding a 1929 style crash and depression. However, while grown men weep in Washington, banks continued to fail – Washington Mutual in the US and Bradford and Bingley in the UK, it is safe to say that this maelstrom is unlikely to end any time soon as the nightmare on Wall Street moves decisively onto Main Street. Last week’s massive swings in the markets may have provided plenty of copy but in reality many are missing the point: it is the chronic lack of trust between banks which is the cause of this mayhem, resulting in a mass flight to quality. Interbank rates are dysfunctional – when a bank would rather earn less than 4% from a central bank than 6%+ from the market then there is something seriously awry.
A recap on last week’s banking woes started with Denmark ’s Central Bank rescuing that country’s 6th largest bank, EBH, its second rescue in 10 weeks after two others agreed to be bought out last week. By Wednesday Gulf Arab States’ Central Banks said they were ready to provide more liquidity, if needed in the parched interbank market. Kazakhstan established a $5b rescue fund for its banks. Hong Kong ’s Bank of East Asia suffered a run by depositors who queued all night to get hold of their money. Even as I write the ECB is meeting to discuss Fortis Bank – the virus continues to spread. “Bank failures are caused by depositors who don’t deposit enough money to cover losses due to mismanagement” sounds just about right and uttered, by all people, Dan Quayle – VP under George Bush Senior!!
The solution to this unfolding catastrophe is to throw money at the problem much like the Japanese banking crisis of late 1980s – explained in detail at www.yen-to-dollar.com. Then, as now, this is only likely to prolong the agony as well as killing off enterprises and companies which are basically sound but whose credit dries up. Once again this week’s economic data is almost irrelevant even though important Q3 numbers are expected: Japan ’s Tankan Survey, UK PMI, ECB interest rate decision and US Non Farm Payroll on Friday. Each of these would normally be expected to move both equity and forex markets. However, given the fear and paralysis together with a number of holidays worldwide, market conditions will be both thin and highly volatile. At the centre of this storm is the fate of the US dollar with its implications to all markets and countries. Setting aside the long held desire of the like of Venezuela , Iran and Russia whose dearest wish is to see an end to the dollar, the fate of the US dollar is inextricably linked to all other markets. An agreement in Washington this weekend may see a dollar bounce and equity markets respond in kind, however, this may prove only a temporary reprieve. Ambrose Evans-Pritchard who is always an interesting read explains in his latest blog post how there is now a very serious risk of a run on the dollar. http://blogs.telegraph.co.uk/ambrose_evans-pritchard/blog/2008/09/23/financial_crisis_does_the_us_face_a_fullscale_run_on_its_currency.
In the forex market the dollar bell weather pair is the dollar yen. At the moment it is the Japanese banking system which is perceived as being insulated from the general crisis and the yen has strengthened accordingly. For forex traders 104 is now pivotal. For those of us who can remember the days when risk was seen as good it was the relentless selling of the Japanese yen in the carry trade pairs which led to many a profitable trade – oh happy days! The moral of the above: The public’s faith in the great and the good to get us out of this mess is both touching and probably misplaced and just remember that in the end it’s always the taxpayer who picks up the bill.
Trading Concept: As traders and investors it is vital we understand correlation and how different markets and instruments relate and move in respect of one another. Two examples: In forex the euro dollar and dollar swiss are almost 100% negatively correlated – going long on both euro dollar and dollar swiss would make no sense at all (or even short on both) as they would cancel each other out. Currently the correlation between oil and the dollar is inverted – a weak dollar has led to a massive increase in the oil price – however this relationship is more fluid and may change in the future – my latest blog http://www.prices-oil.org gives a daily update and comment on the oil price. It’s also available in a Chinese version.
Good luck and good trading.
Anna
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