There is a gathering storm over the global economy and market patterns are now making it plain that the risk of a lightening strike is outweighing the benefits of remaining outdoors.
Regular readers will know that I have been a keen observer of the $US for the past few weeks. I was, so far as I know, the first to identify the breakdown of the traditional “flight to safety” role of the $US. Then, last week, I wrote that:
The risks involved in the flight to safety trade have shifted, yes. But with the $US still the global reserve currency and one side of sqillions of daily trades around forex, commodities and cross border flows, it isn’t going anywhere. The shift in risk has only been sufficient to push the flight to safety outward until this, or some other crisis, is of sufficient magnitude to force dollar retrenchment.
Well, that role is back with a vengeance today.
In fact, we have a whole series of recent trend breakdowns. Gold is up with the $US. Treasury’s are in. All of the energies are up too. Significantly, grains have decoupled from oil and, along with the metals, are all getting smashed. Wheat in particular is a give away, with negative news out of Russia on projected planting having no impact on the selling. Risk currencies are getting hammered, whilst the reserves are all up – euro, yen, frank.
None of them is moving enough to outpace the $US, however.
A story in the FT today suggests just how explosive this move could get:
Hedge funds and forex dealers are betting record amounts against the dollar, reflecting a growing belief that the US currency has lost its haven appeal and that eurozone interest rates will soon rise.
As the crisis in the Middle East has worsened, the latest exchange data show that traders are selling “short” the currency. The big US fiscal deficit and concerns about the effect of rising oil prices have been blamed by some for the dollar’s slide.
Figures from the Chicago Mercantile Exchange, which are often used as a proxy for hedge fund activity, showed that short dollar positions surged from 200,564 contracts in the week ending February 22 to 281,088 on March 1.
This meant that the value of bets against the dollar on the CME rose $11.5bn in the week to March 1 to $39bn, $3bn more than the previous record of $36bn in 2007.
In contrast, speculators have added to their euro holdings amid expectations that the European Central Bank will soon raise interest rates to head off rising inflation.
Jean-Claude Trichet, ECB President, said last week that “strong vigilance” was warranted, a phrase used throughout the bank’s 2005-08 rate-tightening cycle to pave the way for a rate increase at the next governing council meeting. That strengthened the market view in financial markets that the ECB could raise rates at its April meeting and the euro last week rose to a four-month high of $1.3997 against the dollar, taking its gains from a 16-week low of $1.2871 in January to nearly 9 per cent.
“Dollar bears have become a marauding horde,” said David Watt, analyst at RBC Capital Markets. Given the continued losses for the dollar this month, he said it was likely that investors had since added to their bets against the US currency, short of an “absolutely stunning” reversal in sentiment.
“We may be seeing a turn in the longer-term outlook for the dollar – for the worse,” said Kit Juckes, head of FX strategy at Société Générale. He said the US Federal Reserve was likely to react more dovishly to a supply-side inflationary shock caused by rising oil prices than other central banks.
The figures showed that speculators on the CME had raised the value of their bets that the euro would rise against the dollar to $8.8bn, the largest since January 2008, in the week to March 1.
The data confirm the sharp turnround in sentiment towards the single currency from speculative investors, who as recently as January were betting on losses for the single currency on worries over the eurozone debt crisis.
Analysts said the prospect of ECB monetary tightening was outweighing investors’ concerns over the eurozone’s fiscal problems.”
Well, good for them. However, this is a recovery play, not a Middle East crisis play. And they are going to have to cover their shorts, lest they get get caught with their pants down. Especially if, as I suspect, many have borrowed cheap dollars to leverage the bet.
Because today there is the threat of trouble at the centre of global oil production: Saudi Arabia. Robert Fisk reports in the Independent:
Saudi Arabia was yesterday drafting up to 10,000 security personnel into its north-eastern Shia Muslim provinces, clogging the highways into Dammam and other cities with busloads of troops in fear of next week’s “day of rage” by what is now called the “Hunayn Revolution”.
Saudi Arabia’s worst nightmare – the arrival of the new Arab awakening of rebellion and insurrection in the kingdom – is now casting its long shadow over the House of Saud. Provoked by the Shia majority uprising in the neighbouring Sunni-dominated island of Bahrain, where protesters are calling for the overthrow of the ruling al-Khalifa family, King Abdullah of Saudi Arabia is widely reported to have told the Bahraini authorities that if they do not crush their Shia revolt, his own forces will.
The opposition is expecting at least 20,000 Saudis to gather in Riyadh and in the Shia Muslim provinces of the north-east of the country in six days, to demand an end to corruption and, if necessary, the overthrow of the House of Saud. Saudi security forces have deployed troops and armed police across the Qatif area – where most of Saudi Arabia’s Shia Muslims live – and yesterday would-be protesters circulated photographs of armoured vehicles and buses of the state-security police on a highway near the port city of Dammam.
Although desperate to avoid any outside news of the extent of the protests spreading, Saudi security officials have known for more than a month that the revolt of Shia Muslims in the tiny island of Bahrain was expected to spread to Saudi Arabia. Within the Saudi kingdom, thousands of emails and Facebook messages have encouraged Saudi Sunni Muslims to join the planned demonstrations across the “conservative” and highly corrupt kingdom. They suggest – and this idea is clearly co-ordinated – that during confrontations with armed police or the army next Friday, Saudi women should be placed among the front ranks of the protesters to dissuade the Saudi security forces from opening fire.
If the Saudi royal family decides to use maximum violence against demonstrators, US President Barack Obama will be confronted by one of the most sensitive Middle East decisions of his administration. In Egypt, he only supported the demonstrators after the police used unrestrained firepower against protesters. But in Saudi Arabia – supposedly a “key ally” of the US and one of the world’s principal oil producers – he will be loath to protect the innocent.
Indeed yes, as Saudi tremors grow, Obama is reported to be musing on pushing NATO to help Libya’s rebels. Needless to say, this represents something of a strategic bind.
I don’t hold a lot of fears (or hopes) for the end of the House of Saud. It has complete support amongst other Sunni neighbours and lots of money and fire power. Shia but autocratic Iran may, or may not, be a wild card. But how the hell would I know? Nobody knows. And that is the problem that isn’t going away. Any struggle for power on the Arabian peninsula, however one-sided, will only send oil one way.
As for the possibility that the euro might surge instead or as well as the $US, perhaps, but Ambrose Evans Pritchard raises grave doubts:
The demarche is reckless, politically-motivated, and risks causing yet another spasm of the EMU debt crisis. If recovery proves to be more fragile than it looks – vulnerable to a fiscal squeeze in the West and a credit squeeze in the East – this ECB error will have global ramifications.
The ECB’s governors might usefully study Systematic Monetary Policy and the Effects of Oil Price Shocks, a seminal work in 1997 by a Professor Ben Bernanke of Princeton.
The reason why such shocks often lead to slumps is because policymakers make a hash of it. “The majority of the impact of an oil price shock on the real economy is attributable to the central bank’s response, not the inflationary pressures engendered by the shock,” wrote Bernanke.
No doubt ECB governors need to prove their hawkishness after Bundesbank chief Axel Weber walked out of the Eurotower in disgust, more or less stating that he did not wish to take over a body that had departed so far from orthodoxy, and succumbed to political pressure by purchasing the bonds of bankrupt states.
They are right to be worried. The euro lives or dies on German sufferance. The unwritten contract of Maastricht is that EMU must be run on German terms, with a German veto over monetary policy. This contract is being tested.
Dr Weber could hardly have done more to fuel the raging flames of euroscepticism in Germany, where 189 professors have warned of “fatal consequences” if the EU crosses the Rubicon to a `transfer union’ of shared debt liabilities. The three Bundestag blocs in Angela Merkel’s coalition have issued a paper virtually ordering her to resist demands for yet more bail-out concessions at this month’s EU summit.
So yes, the ECB has a credibility problem in Germany. Yet to raise rates into an oil shock – as it did July 2008 when the global system was already buckling – is the central banking cousin of Flat Earth belief.
This is not a repeat of 2008, of course, yet something is still deeply wrong. The M3 money supply contracted in January and December. It has been negative since August (from €9.52 trillion to €9.48 trillion), and so has narrow M1. Private credit is growing at just 2pc.
This is the same bank that sat on its hands through the torrid autumn of 2005, keeping real rates negative as M3 growth rose at 8pc (double the ECB’s reference rate of 4.5pc), and as the Irish/Club Med property bubbles spiralled out of control.
Germany needed rates below the Euroland equilibrium at that moment. This is dirty secret that almost everybody in the German policy debate now chooses to forget, or never acknowledged. The ECB discriminated against Club Med. I should have thought Spain could sue the bank for misconduct at the European Court over that breach of its mandate.
Spain is now being whacked again. One-year Euribor rates jumped 14 basis points to 1.92pc within hours after ECB chief Jean-Claude Trichet uttered the code words “strong vigilance”. As the ECB knows, this is the rate used to price most Spanish mortgages.
Let’s add in record wides in public debt for Portugal, Ireland and soon Greece, as well as the rather obvious fact that tightened monetary policy and a higher euro will be suicidal for the austerity-driving PIGS, and these euro-backing speculators look like they’ve downed a big mug of the kool aid.
Of course, the Bernanke Put is in the mix somewhere, and will ride to the rescue sooner or later, even if various Fedites continue to give off mixed signals. But QEIII can’t come, it seems, until there is clear damage wrought to the US economy by the oil spike.
The first and foremost signal of which will be a tanking equity market.