USD Peso Stages Breakaway Run! Correction Due; Global Liquidity Conditions, Like Deutsche Bank and Euro Money Market’s Dilemma will Play a Role

The Philippine peso was clobbered this week by 1.06% for the fifth consecutive week of losses. The USD phpclosed at 48.50 for the week.

The peso presently owns the tiara as Asia’s worst performing currency on a week on week (top) basis, as well as, year to date basis.

Malaysia’s ringgit has been the second runner-up for the week, while the peso has supplanted the Chinese yuan as tailender on a year to date basis.

 

In my view, the sharp vertical uptick of the USD php has now reached severely overbought levels and could be bound for material contraction or Newton’s law.

But since the currency markets have the tendency to be more volatile, thus Newton’s law may not be as effective as they apply to stocks. But they still apply.

History shows the way.

Over the past three years or since 2013, the USD php has spiked FOUR times.

The biggest vertical move occurred during the taper tantrum where the USD peso soared 7.4% in one monthand two weeks. Newton’s law has not appeared here.

The second leg of the USD php run had another 5.5% vertical run (on top of the 7.4%). It was here where Newton’s law emerged to erase all the gains of the second leg

But the gains from the first leg had virtually been unscathed or untouched.

Newton’s law only took the froth off the second leg but maintained the gains of the first leg which served as a staging point for the third leg.

The third leg was during the 3Q of 2015 where the USD php surged by 4%. Newton’s law reemerged but didn’t take back all of the gains.

That’s because the USD php crawled back to hit a high of 47.995 last January 26 in harmony with the downturn in global markets.

When global central banks went on a full-scale rescue of the stock market via the Shanghai accord where negative rates were implemented, this coincided with the BSP’s unleashing of the stimulus, so along with local stocks, the peso rallied.

But unlike stocks which rebounded furiously, the peso’s ascent had virtually been capped.

As I have noted here, the inverse correlation between the peso and stocks seem to have been broken. It’s only recently where the correlation seems to have been resurrected.

Present events signify as the fourth leg of the USD php upside trend. As of Friday’s close at Php 48.5, this serves as a BREAKAWAY run from the January 26 high.

Such breakaway run makes the USD php at 50 (November 2008 high) a visible horizon.

That’s most likely a target AFTER the USD corrects or sloughs off some of its overbought conditions.

Interestingly, from the close of 2012, the USD php has delivered 18.1% in returns, over the same period the Phisix generated 31.2%.

So the Phisix massively outclassed the USD php. But if I am right those fortunes will soon reverse.

Prices of exchange rates are fundamentally a product of demand and supply.

The surge in USD php has presently been from greater demand for the USD than the peso.

As I have previously observed, this may be a knee-jerk reaction, there may be a real run on the peso, and finally, the peso has been used as a political weapon by geopolitical forces.

Yet this has been happening ironically in the face of reported record GIRs

The BSP also reported its August banking system’s loan conditions as well as the liquidity conditions last week. While the bank loan growth remains substantially elevated (at 4Q 2014 levels), fascinatingly, money supply M3 has sharply decelerated to 11.8% from 13.1%.

It is as if lots of bank borrowers have stopped spending. So the funds that they have borrowed may have been used to hoard cash, pay down debt or buy USD.

And a sustained fall in M3 will likely translate to a downside trajectory for NGDP and nominal sales.

Yet even at 11.8% money supply growth remains a rapid clip. This shows the longer term supply influence of the peso to the exchange rate

 

Another curiosity, growth of government’s external debt plunged to 2.68% last August from the 6-8% range it registered during the past 9 months. Has the government raised sufficient taxes, as well as USD dollars last August enough to cover its deficits last July?

Or has the present improvement been part of the PR campaign to embellish statistics to bolster the peso and the economy’s conditions?

Lastly, not everything will be about the domestic conditions. Global factors will increasingly come into the picture.

The unfolding banking crisis in Europe will also play a big role.

So as with the surging LIBOR and TED spreads in the US (largely blamed to 2a7 reforms), the untamed China’s interbank rate Shibor, and the still ongoing problems Japan’s banking system, as well as, Saudi Arabia’s liquidity problems

It took rumors that Deutsche Bank reached a settlement with the US justice department worth $5.4 billion in fines which have been  far lower than the original $14 billion to stem the collapse in share prices last week.

Because of the massive short positions on Deutsche Bank’s shares, the rumor impelled for an intense short covering which lifted global stocks on Friday. DB soared 14.02% last Friday where the market cap was last at $17.7 billion (yahoo Finance).

And because of a holiday in Germany in Monday, regulators have become so sensitive to any potential liquidity squeezes for them to float temporary responses.

Like Wells Fargo, several employees at the Deutsche Bank have also been charged by the Italian government for creating false accounts. So aside from financial woes, impropriety will partly play a role in the coming sessions.

Rumors have been floated that DB will be rescued, but German’s media says that the German governmentwon’t do this. A bailout by the German government would set a precedent for Italian government to bailout its besieged banks, which the German government has stridently opposed. In my view, further stress in the market will force their hands. But whether the bailouts or bailins will be successful is another matter.

And anent the lingering bank and financial concerns, it’s not just DB, Germany’s second-largest bank Commerzbank announced that it would cut dividends and slash 9,600 jobs. Netherland’s largest lender, theING will also announce job cuts this week. So even banks in creditor nations of Europe are being affected.

Incidentally, USD liquidity conditions have been stretched out at the money markets in Europe such that the cost to borrow USD via cross currency swaps has risen to 2012 levels. And it’s not just in Europe, hedging cost for the USD yen also via cross currency swaps have experienced a “blowout”. These are signs of USD shortages.

The ongoing liquidity shortages have become apparent such that the Saudi Arabian government had to inject $5.3 billion into the banking system to tame surging interest rates and contain stress in her currency, the riyal. 

As the chart from the Alhambra Partners shows, the surge in US TED spread has mirrored (inverse) DB’s share prices (along with many other price signals including treasury fails) way back to 2014.

As the prolific analyst and research manager Jeffrey Snider wrote:

While attention is rightly focused on Deutsche Bank it is only so because the bank is the most visible symptom being the most vulnerable participant in this “something.” DB is just an outbreak so prominent that the mainstream can no longer pretend there is nothing worth reporting – but they can still obscure why that might be, focusing on the canard about the DOJ settlement. This is a systemic issue, one that is as plain as Deutsche’s stock price.

Liquidity risk is indicated pretty much everywhere, a direct assault not just on mainstream conventions about monetary policy but monetary competency itself.

Use any weakness in the USD to accumulate.

Quote of the Day: Europe is Drowning Under the Cost of Welfare Bills

A debt crisis in Europe seems inevitable. Reason? Exploding costs of welfare politics.

Telegraph's Matthew Lynn explains:

Europe’s welfare spending is out of control, and is on a scale that is both lavish and unaffordable compared with the rest of the world. There is a problem, however. Neither she, nor any other political leader in Europe, has the will to do anything about it.

Eurostat, the statistical agency of the European Union, has this week published updated figures on the total welfare bill across Europe. It is rising, and in some countries is getting up to a quarter of national output. Meanwhile, the percentage of spending on stuff like infrastructure or education, which increase an economy’s potential output, is falling.

So long as that is true, it is very hard to see anything other than a bleak future for any of Europe’s economies.

If you dip into the blogs, there is a mildly entertaining debate about whether Merkel’s often-quoted figures are correct. On close inspection, it turns out that nations that make up the EU currently account for 7.2pc of the world’s population and a shade over a quarter of total output. When the World Bank crunched the numbers on social spending, however, it found that in fact Europe accounts for a massive 58pc of global welfare spending.

What is certainly true is that Europe’s welfare budget has turned into a juggernaut that is careering out of control. On the World Bank data, the United States accounts for 18.8pc of global welfare spending, as you might expect from the world’s biggest economy. But Germany, around a third of its size, currently spends 12.5pc of the global total. France, a smaller country still, accounts for 9.9pc. The UK racks up close on 7pc. Contrast that with some far bigger, and faster- growing, countries. China, with 20 times our population, accounts for 2.4pc of the total. Russia accounts for 2pc and India just 0.6pc.

According to Eurostat, the total cost of welfare across the EU now amounts to 19.5pc of total GDP, compared with 17.5pc as recently as 2006. If you restrict that to the eurozone countries, the total rises to 20.5pc. In Denmark and France it is now close on 25pc.

For all that the Left complains about austerity in this country, our total spending on social protection is only slightly below the European average at 16.5pc of GDP. In controversial areas such as disability benefits, where the Government has now abandoned some modest cuts, we are in line with the EU average, spending 2.8pc of GDP. (Our welfare bill is only less than average because a fantastic performance on job creation means we spend just 0.2pc of GDP on unemployment, compared with a eurozone average of 1.8pc, and 2pc in a country such as France).

Overall, in almost every country, it is going up. With ageing populations, that is hardly likely to decrease – poverty-stricken Greece is now spending 15pc of GDP on pensions, and Italy 14pc. Europe is literally drowning under the cost of its welfare bills.

Former Bank of England Mervyn King Warns the Eurozone is Doomed!

It's interesting to see to former officials eschew establishment line to adapt a radical perspective. And it's even more intriguing when such proselytism comes from an ex highest central bank official of a developed economy.

I am talking of Mervyn King, the previous Governor of the Bank of England, who in his recent book, predicted that Eurozone will not only be headed to the gutters, but would likely dismember.

Here's the Telegraph:(bold mine)

He warns of a looming “economic [and] political crisis” triggered by endless bail-outs, austerity demands and pressure from the “elites in Europe” and the US to create “a transfer union” to solve the eurozone’s woes.

In the second extract of The Telegraph’s exclusive serialisation, Lord King warns that this has “sowed the seeds of division” in the bloc and created support for populist parties. Further steps towards political union, where countries are forced to cede sovereignty and yield to Brussels diktats, could spark a public backlash.

“It will lead to not only an economic but [also] a political crisis,” he says. “Monetary union has created a conflict between a centralised elite on the one hand, and the forces of democracy at the national level on the other. This is extraordinarily dangerous.”

However, Lord King, who often used sporting analogies during his decade at the helm of the Bank of England, says the alternative of struggling countries such as Greece being “temporarily relegated” from the bloc to regain competitiveness may also be “too late”.

Policymakers, already scarred by repeated rounds of brinkmanship, are unlikely to reach an accord, he argues. “The underlying differences between countries and the political cost of accepting defeat have become too great.

“That is unfortunate both for the countries concerned – because sometimes premature promotion can be a misfortune and relegation the opportunity for a new start – and for the world as a whole because the euro area today is a drag on world growth.”

Germany and the rest of the eurozone must “face up” to the fact that uncompetitive countries in the south can only prosper again if the bloc is broken up, Lord King argues.

Europe’s biggest economy faces the “terrible choice” of writing a blank cheque to support the bloc “at great and unending cost to its taxpayers” or calling “a halt to the monetary union project”, he says.

The “only way” to stop countries staring into the abyss of “crushing austerity, continuing mass unemployment” with “no end in sight to the burden of debt” faced by debtor nations is for them to abandon the euro.

“The counter-argument – that exit from the euro area would lead to chaos, falls in living standards and continuing uncertainty about the survival of the currency union – has real weight,” Lord King says.

“But... leaving the euro area may be the only way to plot a route back to economic growth and full employment. “The long-term benefits outweigh the short-term costs.”

The misguided ramrodding of inflationism to the public, or hidden taxation through currency debasement as subsidy to the political elites in order to prolong an unsustainable debt financed welfare warfare state,  the efforts to empower the unelected bureaucracy through increased centralization at the expense of the average citizenry, the deepening suffocation of the economic agents through imposition of byzantine taxes, regulations and mandates, the forcible integration of divergent societies, and presently, the 'refugee crisis' as consequence of the warfare state only provides clues to the path of the eventual demise of the EU.

I am reminded by the mainstream's economic icon, JM Keynes's trenchant perspective on inflationism which leads to the destruction of society. (bold added)

Lenin is said to have declared that the best way to destroy the capitalist system was to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some. The sight of this arbitrary rearrangement of riches strikes not only at security but [also] at confidence in the equity of the existing distribution of wealth.

Those to whom the system brings windfalls, beyond their deserts and even beyond their expectations or desires, become "profiteers," who are the object of the hatred of the bourgeoisie, whom the inflationism has impoverished, not less than of the proletariat. As the inflation proceeds and the real value of the currency fluctuates wildly from month to month, all permanent relations between debtors and creditors, which form the ultimate foundation of capitalism, become so utterly disordered as to be almost meaningless; and the process of wealth-getting degenerates into a gamble and a lottery.

Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.

EU's modern day application of "all permanent relations between debtors and creditor...become so utterly disordered": from ZIRP to NIRP to war on cash.