Currency Wars: Trading the Driver$
Abridged from the November edition of TRIGGER$
Since September, the Currency Wars have escalated. It isn't just because of the seminal monetary events of the Federal Reserve's QE III "unlimited" and the ECB's OMT "Uncapped". It is highly likely, more about the fact that China announced its eleventh agreement that effectively bypasses using the US dollar with China's strategic trading partners. The latest agreement with Russia places trading oil, in non-US dollars, into the spotlight. The infamous petrodollar has had its destructive profile raised.
The Petrodollar has long been the cornerstone that solidified the US dollar as the key currency reserve holding. The Petrodollar strategy is arguably more important that the Bretton Woods agreement which officially made the US dollar the world's reserve currency at the end of WW II. This is now being called into question. Minimally, it suggests a weakened requirement for holdings of the current levels of US dollars in sovereign reserve accounts.
For the sake of space I won't lay out all the details of this but instead refer you to two recent video releases I have produced and participated in on the subject.
What is important to Traders is what it means to your trading strategy in the short to intermediate term. To Investors it has profound longer term consequences.
To determine short term effects, we first need to understand the relationship of the Driver$ involved. The three critical currency relationships near term are the US$, the € and the ¥. Then we need to understand how they will effect US Treasury yields.
First however it is important to understand the controlling mechanism of global fiat currencies.
The $67 Trillion Shadow Banking System (The Fiat Currency Control Block)
The Global Economy is approximately $70 Trillion. According to a just released report by the Financial Stability Authority (FSA), charged with investigating it globally, the Global Shadow Banking System was $67T in 2011.
It is up a staggering $6T in 2011.
This means that unofficial, unregulated, offshore entities now effectively control the pricing of global fiat currencies. Through the $637 Trillion SWAP market (also unregulated and offshore trading currency, interest & credit default swaps) they in turn control global interest rates.
The major currency domiciles within the Shadow Banking Industry. It's called absolute control.
¥: The Early December Japanese Election is likely to result in dramatically increased BOJ Liquidity, Negative yields and the political process dictating to the Bank of Japan in attempt to devalue the Yen for competitive trade advantage as the Japanese trade balance worsens.
$: A political resolution to the Fiscal Cliff that results in a Credit Downgrade of US Debt.
€: Though the € will rise relative to the dollar and Yen it is more about the resumption of the Yen Carry Trade and a slowing of the "Flight to Safety" Trade dominating the EU for months.
Consider first the Euro : Yen Cross
The rising green arrow in the above graphic is more about a planned and managed attempt at weakening the Yen than strength in the Euro.
The YEN must be weakened as its strength is crippling Japan's export economy.
The Yen will soon start weakening SIGNIFICANTLY against the Euro
EU-EURO SITUATIONAL ANALYSIS (charts below):
- The present strategy in the EU is a "Political Union" and to change the treaty accord to put EU "teeth" into countries having to take stronger actions to bring their debt within EU targets. There is no solution given on how the EU does this other than austerity, which almost assures economic weakness and possible collapse going forward. Expect increasing broad based social unrest.
- The hidden and real reason for this is to change the mandate of the European Central Bank (ECB) to allow it to become the "lender of last resort". This is an euphemism for 'allowed to print money'. The mandate of the ECB is different than the US Federal Reserve and the hidden agenda is to change this.
- As we predicted in previous reports, and is now showing signs of coming to fruition, we expect Spain / Portugal & Italy to soon launch the next and more serious round of the EU crisis. Keep your eye on France and other peripheral nations such as Cyprus, the Netherlands. The fact Poland has deferred Eurozone entry is very telling.
- The only solution for the EU is the ECB monetizing money for funding bailouts. Draghi began this process in September with OMT or SMT2 which is OPEN ended. Support in the German courts and by Merkel suggest the Euro should strengthen somewhat in the near term. It will be more about the YEN and US$ weakening than the Euro strengthening
The final chart show what in fact occurred over the last 30 days and what we presently anticipate:
US Treasury Debt & Fiscal Cliff
This chart shows what we presently anticipate . "THIS IS A MAJOR INFLECTION POINT.
Potential for further Financial Repression
Expect a correction and consolidation."
REMEMBER: Financial Repression is at work here and US Bond Yields and Interest Rates MUST be further reduced.
We presently expect the 10 Year US Treasury Bill to eventually break below 1% which supports the potential target shown above & below.
This is a Well Managed and Controlled Regression Channel
as the developed world tries to rebalance within global imbalances.
The global economy is near stall speed as the already attempted stimulus and monetary policies have failed to deliver. The controllers of the fiat currency camp (US, EU, Japan and UK) must therefore further lower REAL yields and extend duration through central bank guarantees.
They will do this in attempt to buy further time until the 'magical' recovery happens.
Frankly, the politicos know of no other recourse despite it having already failed continuously.
Japan has just completed its ninth Quantitative Easing and have concluded ZIRP now needs to be NIRP (negative Interest Rate Policy). It is highly probable that this will reignite the Yen Carry Trade and strengthen the US$. In turn this will hurt equities and compress PE ratios further.
Expect violent counter rallies as the right shoulder is put in, within a long term, 10 year Head and Shoulders pattern.
Traders need to carefully watch the US$, the € and the ¥. cross relationships and credit spreads associated with US Treasury Yield curve and High Yield (HY) "B" rated instruments.
Good luck, and good trading.