Currency War or Currency Defences ?

When you read a headline like this one “Bayer’s profits rise on healthy currency effects“, some of you may start to wonder what is “healthy” ?

 

Because the truth of the matter is that sales are not growing.

 

“2015 outlook for operational performance of continuing operations confirmed, adjusted for FX effects. Sees full-yr sales of ~EU47b vs EU48b-EU49b previously” Source : Bloomberg.

 

On the other hand, “Procter & Gamble is getting slammed by the strong dollar” and “Truck-maker Oshkosh’s profit falls as strong dollar weighs“.

 

Is the USD “unhealthy” then ?

 

For P&G and Oshkosh, certainly. Companies that derive their income from overseas markets will feel the pinch when translating that back into USD terms.

 

The USD has been the big no brainer trade for the past 12 months, with the DXY Index delivering a 20% return which is actually great news for offshore equity investors in the US stock markets as returns are amplified with the currency effect e.g. 20% from the USD and another 9% from the S&P 500.

 

Long positions in the DXY Futures are 3 times above their 5 year average and nearly 5 times more than their 10 year averages, even as EUR shorts recovered off their  10 year lows. The biggest loser is in EM FX which are trading at their 5 year (or more years) highs led by commodity exporter currencies.

 

The MSCI EM FX Hedge [USD] Index reflects the investment process of hedging the currency exposure of the MSCI Emerging Markets Index in USD.

Currency War or Currency Defences

You see the world market is in an UNHEALTHY state, akin to being in a coma for the past 7 years.

 

We have lived in the longest period of Fed inaction, possibly in history.
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Their inaction and relentless QE has led to the state of the markets today, US hike vs the rest of the world on currency war cut mode.

 

Now, the Fed Funds are awaking from their coma, what do you think ?

 

Discomfort, disorientation, disbelief ?

 

No one will be prepared for it and whatever happens will depend on one’s luck, don’t you think ? Yes, the winners will go on and write a book about their incredible acumen but really, it is all a matter of luck because this is unprecedented.

 

And Luck is always better than Smart, as usual.

 

So what are all the rational bones in our bodies telling us now ? The USD no brainer story ? China has devalued twice in 2 days so with Luck, it will continue to capitulate into the day of reckoning on the 18 September FOMC even as the expectations for the future are lower than a year ago.

 

Currency War or Currency Defences 2

 

The key takeaway is that it will be a slow climb with an initial rude jolt like it is when one awakens from a prolonged coma and given that economic growth will be at best slow, I believe that panic will soon give way to market fatigue which makes perfect sense for a pause in the USD rally that has been taken for granted for the past year.

 

Now we have the DXY hovering near its 12 year highs and the ADXY making 6 year lows.

 

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DXY INDEX

 

Currency War or Currency Defences 4

ADXY INDEX

 

I think today would be intervention day for most EM central banks but it is just a healthy rally of unwinding all the excesses of the carry trade that QE had presented and the building up of USD longs in anticipation of the first Fed hike, speculation against the EM basket and commodity weakness.

 

While analysts are giving us the 101 reasons to be long the USD, the prospect of the 25 bp does not do it for me, like I said last month, and it is probably a good time to start looking for hedges and exits on the next uptick or Minsky moment. And I am not going to try to be smart about it this time.