Posts filed under “Think Tank”

The Dollar’s Role in Rising Risk Appetites

Good Evening: After a couple of wobbly sessions on Friday and Monday, U.S. stocks resumed rising on Tuesday. With little in the way of economic news, it was left to a falling dollar to buoy investor risk appetites. The greenback obliged by setting a new low for 2009, and commodity prices understandably reacted by heading in the opposite direction. Interestingly, however, Treasury yields and credit spreads didn’t rise with renewed dollar weakness; they instead fell. Falling interest rates and rising equity values may cause the FOMC to issue a statement of self-congratulations after their two day confab breaks up tomorrow, but what our central bankers may not realize is that one of the important policy linkages for the levitation in our asset markets is the greenback itself. Carry trades are back and the new funding currency of choice is the U.S. dollar.

Stocks around the world were mostly higher overnight. Japan remained closed, and while China’s CSI 300 dropped more than 2%, other Asian markets and most of Europe’s bourses were quite firm. Thus encouraged, U.S. stock index futures were modestly higher as Tuesday’s opening bell approached. The economic data was a non factor in today’s trading. Weekly chain store sales results were disappointing; a government measure of home prices rose; and the Richmond Fed survey reading of +14 in September showed no improvement from August. Stocks opened 0.5% higher and traded mostly sideways until the results of the Treasury’s latest auction results were posted.

Despite a tiny yield of just over 1%, the demand for the $43 billion (a record) of 2 year notes was the strongest since 2007. Central banks took down approximately half the auction and the bid-to-cover ratio was well over 3. The major U.S. stock market averages hit their highs for the day just before these results hit the tape, and they spent the rest of the day hovering within shouting distance of their best levels. The NASDAQ (+0.4%) slightly trailed the other indexes, while the Russell 2000 (+0.8%) sported the best gain. As mentioned, Treasurys rallied and their yields fell between 3 and 10 bps. The greenback was clobbered at the open and never once lifted its head off the canvas. The U.S. dollar index fell 0.9% and set a new low for 2009 in the process. Commodity market participants were emboldened by the hapless buck and they found little resistance as they pushed the CRB index almost 2% higher on Tuesday.

“How”, starts a typical question I’ve been asked this month, “can stocks, bonds, and commodities continue to rise together?” My briefest response is “money printing”, and a more nuanced version of the same reply describes how risk appetites have been rising due to low interest rates and quantitative easing. Only the most persistent readers are unsatisfied by this explanation. “Why?”, or “what’s the linkage between the two?” come the dogged responses, as well as the ever-popular “who is doing all the buying?” In addition to disgruntled shorts and unhappily underweight portfolio managers, the busiest buyers these days are hedge funds and bank proprietary trading desks. They are putting on carry trades, and the latest funding currency of choice is none other than the U.S. dollar (see below).

For the uninitiated, a word of explanation is in order. A “carry trade” is any trade whereby an entity borrows money and uses the proceeds to buy assets. The money borrowed is short term in duration (usually overnight) and the assets purchased are longer term ones — ranging from 30 days (commercial paper) to infinity (equities). In the broadest sense, almost any asset can be bought with borrowed money and end up on the right hand side of the ledger in a carry trade, but the vast majority of carry trades take place in the fixed income world. Banks effect such trades every day, borrowing in the fed funds market and buying 2, 3, and 5 year notes, hoping to earn the yield differential in the process. Almost always, this yield differential is positive, giving an investor what is called “positive carry” (hence the name carry trade). The classic carry trade is done in one’s home currency, and the assets purchased are usually government securities with short and intermediate maturities. If this trade sounds easy, it is. But this trade carries with it the risks that the overnight borrowing rate can rise, that the asset purchased can fall, or, as in 1994, a dastardly combination of both.

Let’s return to the original question of linkage between Fed policy, rising risk appetites, and the role carry trades play in boosting asset prices. If banks borrowing in the fed funds market to buy short term Treasurys is the “classic” carry trade, then it shouldn’t surprise you to learn that hedge funds and the prop desks of large financial institutions often take the carry trade to more sophisticated heights. The desks at these shops will borrow overnight to buy corporate debt, leveraged loans, and even high yield debt. Not content to stay at home, they will also shop worldwide for the lowest overnight rates in which to borrow, and they will likewise engage in a global search for the most beguiling assets. In addition to the risks facing the classic carry trade, these global carry trades have an added one: an inconvenient rise in the currency in which they have borrowed.

Managing these multiple risks requires that traders putting on carry trades in currencies other than their own be confident the borrowed currency will stay weak. For almost two decades, the 98 pound weakling currency targeted for borrowing was the Japanese yen. In the wake of the bursting of their twin bubbles in both stocks and property in late 1989, Japan’s economy has been a basket case and the BOJ has kept short term interest rates at microscopic levels. Except for the occasional eruption and rush by borrowers to cover shorts, the yen mostly stayed weak during this period. The yen carry trade was so profitable it became a prime tool of global speculation. When the global panic of 2008 hit, the yen rallied fiercely as risk appetites shriveled and forced carry traders to sell assets and pay off their yen denominated debts. Why, then, if risk appetites have been rising for months, has the yen not fallen under the weight of new carry trades?

The answer is that the currency getting sand kicked in its face these days is the U.S. dollar. Back in March, our Federal Reserve pushed the fed funds target toward zero. When dollar-based LIBOR rates eventually followed, the cost of borrowing in dollars to effect carry trades fell below the cost of borrowing in other major currencies. According to a piece put out by Capital Economics this morning, “(o)ne explanation for the dollar’s weakness is its increased use as a funding currency. The 3 month interest rate differential between the U.S. and a weighted average of its major trading partners has swung from more than 2% a few years ago to below zero today”. What’s more, the Fed’s quantitative easing program, which involves the purchase of billions of Treasurys and mortgage-related securities, effectively put a floor beneath the prices of these securities.

With the lure of a weak currency, the lowest borrowing rates in the world, and a central bank willing to backstop the bond market, speculative capital the world over is finding its way here. The Fed has turned King Dollar into a source of princely profits for global carry traders. Until the perception of a weak dollar changes — whether due to a shift by the Fed to a more stringent monetary policy or to a sudden cooling in risk appetites — the market moves we’ve seen since March could be with us for a while. In this environment, the greenback could remain friendless — even with bullish sentiment for the buck fetching less than a dime. To answer the original question, the dollar can continue to fall and dollar assets can continue to rally as long as the dollar carry trade continues to live.

Catalysts which might upset this happy state of affairs for our markets and our central bank are numerous, but they include the Fed itself. If tomorrow’s FOMC meeting produces a policy statement which overtly entertains the notion of an exit strategy, it is possible the latest dollar carry trades could start to be unwound. Another potential negative catalyst for risk appetites is this week’s G-20 meeting. If the politicians propose some new and goofy regulatory framework that somehow makes it harder for the hedge funds and prop traders to make money, then this news, too, could set off a correction that sees stocks and commodities fall against the backdrop of a rising dollar. And, of course, there is always the possibility of an exogenous shock that will cause those currently gorging on risk to see some of their positions make a reverse journey through the financial equivalent of the alimentary canal. Until some event occurs, however, rising risk appetites and the dollar carry trades that feed them will be a large influence on asset prices.

– Jack McHugh

U.S. Stocks Gain, Extending Global Rally, as Dollar Slips
Credit Swaps Traders Pay Least for Debt Protection in 16 Months
Hedge Funds’ ATM Moves From Tokyo to Washington: William Pesek

Category: Markets, Think Tank

The Drunk and the Liquor Store

David R. Kotok co-founded Cumberland Advisors in 1973 and has been its Chief Investment Officer since inception. He holds a B.S. in Economics from The Wharton School of the University of Pennsylvania, an M.S. in Organizational Dynamics from The School of Arts and Sciences at the University of Pennsylvania, and a Masters in Philosophy from the University of Pennsylvania. Mr. Kotok is also a member of the National Business Economics Issues Council (NBEIC), the National Association for Business Economics (NABE), the Philadelphia Council for Business Economics (PCBE), and the Philadelphia Financial Economists Group (PFEG).


A few thousand miles of flying gives one a chance to catch up on some research reports. In this case the stack was about the debt-to-GDP ratio and what it means.

It is clear that the United States is on a borrowing binge. And also clear that the Nancy Pelosi-led US Congress has no will to restore any discipline to its spending habits.

Now we all know that borrowing at increasing rates cannot go on forever. And we also know that it can go on for a long time. And history shows that the adjustment process is non-linear. In other words, there is a period when the increased borrowing in order to finance consumption seems to be painless. We are in that period now.

This usually is followed by a shock. What triggers the shock? When does it occur? These are the types of questions we wrestle with each day as a money manager. And these are exactly the questions without easy answers. A bunch of research reports has proven that to these tired eyes.

Here is what we do know. The total of all government debt in the US has now breached the 100% of GDP level. We get this number courtesy of Ned Davis and by tallying up all the debt of the federal, state and local governments. This ratio has not been this high since World War II. It is climbing in a vertical fashion and can be projected to set a new record each and every foreseeable month.

Unlike World War II, the US debt explosion is not due to military and interest expense. Ned Davis has calculated the spending to GDP ratio without interest payments or defense. Again we are at an all-time high in the post World War II period. We cannot blame the spending spree on the army.

Total credit market debt to GDP in the US is a record 373% as of June 30th. In the UK it is 233%. In Japan it is 225%. We have become the most profligate borrower of the large countries in the world.

Private sector and household debt is not the problem. In the last two months the household debt declined by a huge $37 billion. Non-financial corporate debt is also not the problem. It is barely increasing.

The problem simply is government. It is borrowing at all levels and without restraint.

From Japan we learned that increasing borrowing can continue for a very long time. And that we can get it without much inflation and with persistent very low interest rates. The reason is that borrowing is a way of loading a debt burden on the economy. The larger the debt burden the slower the economy will grow. This is especially true when the borrowing is for consumption purposes. That is the current condition of the United States.

Read More

Category: Think Tank

July FHFA Home Price Index

The July FHFA Home Price Index rose .3% m/o/m, .2% less than expected and June was revised lower to a gain of .1%, down from the initial report of up .5%. Y/o/Y prices are down 4.2% and are (only) 10.5% below its April 2007 high. According to the FHFA, their index is back to the…Read More

Category: MacroNotes

Will the US$ be an FOMC topic of discussion?

As the FOMC begins their two day meeting today not only will they have to juggle the current stabilization in the US economy with their extremely accommodative policies, I wonder whether they will discuss the US$ and the price of gold as price stability (stable currency) is one of their two mandates. The $ index…Read More

Category: MacroNotes

Did Policy Economists Get It That Wrong?

Bob Eisenbeis is Cumberland’s Chief Monetary Economist. Prior to joining Cumberland Advisors he was the Executive Vice President and Director of Research at the Federal Reserve Bank of Atlanta. Bob is presently a member of the U.S. Shadow Financial Regulatory Committee and the Financial Economist Roundtable. His bio is found at He may be reached at

It has become fashionable for commentators to bash economists for having missed the financial crisis of 2007-2009. Nobel Prize winner Robert Lucas provided a recent rebuttal to critics in a guest article in The Economist of August 6, 2009. Unfortunately, it was a rather unconvincing effort.

More recently, Nobel laureate Paul Krugman, in his NY Times article of September 2, 2009 entitled “How Did Economists Get It So Wrong?” took his own shots at the profession. He essentially repeats two criticisms that were addressed in Lucas’ article. The first is the profession’s fixation on elegant mathematical models, and the second is its belief in efficient markets – the idea that market participants use all available information when making economic decisions and pricing securities. He claims that in the world of theory – which many economists tend to believe is the “real” world – markets are inherently stable and do not admit the possibility of “catastrophic failures in a market economy” like the current crisis. Should a problem occur then it could be easily corrected by appropriately administered Federal Reserve policy. Are these criticisms well-deserved and are they directed at the right people?

Krugman’s critique has brought forth a host of rebuttals from academic economists who defended their performance. Still, one has to concede that Krugman has some valid points. The first concerns the bias among theorists for stability and stationarity in their models. Models serve a useful purpose in all fields of physical and social science. In economics, the trend has been toward building models that exhibit stationarity and stability, so that they tend toward a fixed long-run equilibrium and naturally return to that equilibrium if shocked. Publish these types of models and you will advance your academic career. There has been relatively little interest in the contemporary academic profession in market imperfections or in models that may admit such properties.

However, what critics also fail to recognize is that academic economists are not engaged in the same activity as business and policy economists. Academics are not building forecasting and prediction models of the kind the critics seem to be demanding or expecting. Academic economists are mostly unconcerned and largely uninformed about the week-to-week data releases or the policy moves that the Federal Reserve makes and that fill time on CNBC, Fox Business, and Bloomberg TV. In fact, academia puts little value on forecasting. Once you have built a forecasting model, there is nothing more to be gained intellectually from the academician’s perspective by running the model week by week as new data becomes available. This is really the province of the Federal Reserve and other government agencies, economic consultants, the business economists that populate Wall Street and large corporations who have to make business and policy decisions based upon the outcomes of those forecasts.

Read More

Category: Think Tank

When do we junk the velcro for the shoelaces?

As my 7 year son last week junked his velcro sneakers for a pair of Nike’s with shoelaces as he finally learned to tie them, it was hard not to think about when the private sector was finally going to learn how to tie its shoelaces again without the help of government velcro. The FOMC…Read More

Category: MacroNotes

Words from the (investment) wise 9.20.09

Words from the (investment) wise for the week that was (September 14 – 20, 2009)

Marking the one-year anniversary of the Lehman Brothers demise, risky assets last week again marched higher to the tune of economic data supporting the argument of a global economic recovery. A realization among investors that the economic transition from recession to recovery was gaining momentum, resulted in many global stock markets scaling fresh peaks for the year.

Ben Bernanke, Federal Reserve chairman, on Tuesday said the US recession “is very likely over”. However, he remained cautious about the shape of the recovery and said he expected a “moderate” recovery in 2010 with growth “not much faster than the underlying potential growth rate of the economy”, i.e. approximately 3%.

“At the moment we don’t see (the economy) getting better or worse, but that’s better than you could say six months ago,” added Warren Buffett. “The terror of last year is gone and that’s thanks in part to the government.”


Source: Tom Toles,

Not only did the US stock market indices record up-days on every day except Thursday, but all ten economic sectors that make up the S&P 500 also closed the week in the black. Most other stock markets (mature and emerging alike), commodities, oil, precious metals, high-yielding currencies and corporate bonds also put in a stellar performance as a bullish mood prevailed.

The CBOE Volatility Index (VIX), or “fear gauge”, traded at about the same level (23.9) as before the Lehman bankruptcy in September last year. Also, government bonds and other safe-haven assets such as the US dollar and Japanese yen were out of favor as investors sought higher returns elsewhere.

As investors started assuming more risk since March, the US Dollar Index headed lower, hitting a one-year low last week and trading in a confirmed downtrend as far as primary trend indicators are concerned. The combination of low interest rates and quantitative easing has made the US dollar an attractive currency for funding carry-trade transactions (i.e. selling low-yielding currencies to finance the purchase of higher-yielding currencies). (Click here for a short technical analysis.)

The declining dollar, central bank purchases, the de-hedging by gold producers and rising inflation expectations served as catalysts for gold bullion’s strength, causing the yellow metal to close above the $1,000 level for the sixth consecutive day on Friday. While gold’s move grabbed the headlines, platinum (+42.5%) and silver (+50.5%) have actually outperformed gold (+13.9%) significantly since the start of the year.



The past week’s performance of the major asset classes is summarized by the chart below – a set of numbers that indicates an increase in risk appetite.



A summary of the movements of major global stock markets for the past week, as well as various other measurement periods, is given in the table below.

Read More

Category: Think Tank

The Hole in FDIC

The Hole in FDIC
September 18, 2009
By John Mauldin

Elements of Deflation, Part 3
Outrageous! – Artificial Deflation!
If You Are in a Hole, Stop Digging!
The Hole in the FDIC
How Can Just Four Stocks Be 40% of the NYSE Volume?
New Orleans and a Mauldin Migration to Europe

This week we continue to look at what powers the forces of deflation. As I continue to stress, getting the fundamental question answered correctly is the most important issue we face going forward. And the problem is that we cannot use the usual historical comparisons. This week we look at one more factor: bank lending. I give you a sneak preview of what will be an explosive report from Institutional Risk Analytics about the problems in the banking sector. Are you ready for the FDIC to be down as much as $400 billion? This should be an interesting, if sobering, letter.

But first, Dennis Gartman and Greg Weldon will be joining me next week for another Conversation with John Mauldin. This is my subscription service where I sit down with my friends and let you eavesdrop on our conversations (we also transcribe them). Dennis and Greg are two of the premier traders and data mavens in the world, and we will be all over the world of commodities, currencies, and the markets. I can tell you, it will be one exciting conversation for me.

It won’t be too long before it will be time to do another Geopolitical Conversation with George Friedman. George and I are doing a conversation quarterly, and right now it is a bonus if you subscribe to Conversations with John Mauldin, but the plan is to offer it separately for $59. Now, here is the important part:

all current subscribers and anyone who subscribes now will receive these Geopolitical Conversations free, as a thank you. If you have not yet subscribed, you can do so and receive a discount by clicking the link and typing in the code JM49
to subscribe for $149. This is a large discount from our regular price of $199; plus, we are including the bonus Geopolitical Conversations that are worth $59.

And now, to the regular letter.

Outrageous! – Artificial Deflation!

Speaking of deflation, let me mention something I find totally outrageous. Normally, I actually take up for the bureaucrats who are stuck with the task of trying to monitor inflation. It is a tough job, and like Monday-morning quarterbacks, everybody thinks you should have done it differently. I can understand the rationale for hedonic measurements, housing rent equivalents, etc., even if I don’t agree with them. You have to set some rules and live with them. But the latest imbroglio is disgraceful.

It seems the US Bureau of Labor Statistics, in the CPI next week, will treat the subsidy received by those 800,000 car buyers who bought a car in the “Cash for Clunkers” program as if the price of a car fell by $4,500. Really? My tax dollars account for nothing?

This does several things. It will decrease the inflation used to adjust the GDP for this quarter. Not the end of the world, but annoying But what really matters is that the CPI is used to calculate Social Security increases and interest paid on TIPS.

If I tried to defraud one of my clients using such accounting legerdemain, I would be shut down, sued, and taken to court (at the minimum) by the host of regulators who look over my shoulder. And I should be! You don’t make such changes in the rules to your own benefit. But that is what the BLS did. This policy should be overruled immediately. There are enough deflationary forces in the world without having to artificially create some more. OK, off the soapbox and onto the banking system.

If You Are in a Hole, Stop Digging!

Right outside my office window I am watching what is to me a visual parable for the banking crisis that has beset the world. I lease a rather large home in a nice, quiet neighborhood in Dallas, and moved my office here last year, as we can use the extra bedrooms and sitting areas. Besides saving a lot (!) of money (always a good thing), it gives me a ten-second commute as I walk down the hall to the back of the house. Tiffani and I each save over a month in driving time a year. That is huge.

My quiet neighborhood changed a few weeks ago. Trying to sleep in the morning after the Paul McCartney concert, I awoke to find with my bed literally vibrating. Earthquakes in Texas? No, it seems my neighbor decided he needed a bigger home, and the first thing to be done was to tear down the old one, which they did rather efficiently, if not quietly, over the next few days. We
literally had glasses and other items vibrating in the house.

Then, after removing a large pecan tree, they proceeded to dig 25-foot-deep holes (26 of them!) and fill them with iron and concrete piers on my side of the lot. The plans called for a rather large basement, and the very experienced builders (exceptionally nice guys) wanted to make sure the earth did not move, causing my home to have problems. So for three days I had a very noisy drill literally ten feet away from my window (I wrote an e-letter during one of those days).

Now, since the other sides of the lot were on a street or backed up to an alley, they did not put in piers there. No homes to worry about. I did not think much of it, as these guys had built some of the biggest and nicest homes in the area. They then proceeded to dig a very large hole, as the basement was going to be quite expansive. It turns out you have to dig the hole bigger than the actual size of the basement, since you have to have room to put up forms to pour concrete, etc. And you have to excavate on an angle. At the end of the process, most of the lot was slanting downward toward the end of the hole near
the alley.

Then the clouds darkened, and the builders realized we were in for a little rain. (You can start to guess!) They took precautions and put heavy plastic over the sides of the hole to keep the sides dry. And then the rains came. Texas rains. The plastic was pulled from its wall and the street side of the hole began to literally wash back into the hole as we watched, going all the way back to and under the sidewalk. The poor builders showed up and began the process of trying to mitigate the damage, but it had been done and only got worse as it continued to rain for three days. The next morning I was the temporary owner of lake-front property. Those piers on my side were starting to be exposed.

They brought in crews for emergency repairs to the sides of the hole, and they really went after it. What to do then? It seems that the only thing to do was to fill the hole back up and start all over, only this time putting piers around the whole property. Which is what they are doing now. But since they had taken all the original dirt away, they are now having to take dirt from the rest of the property to fill the hole they will redig later.

Read More

Category: Think Tank

Baltic Dry Index, lowest since May

The Baltic Dry Index has fallen today to the lowest level since mid May, down for a 6th straight day at 2,356. It still remains 255% off the Dec lows but is now down 45% off the late May ’09 high and is 80% below the record high in May ’08. To give perspective on…Read More

Category: MacroNotes

Morning Stuff

Following the two biggest back to back volume days since early August, we’ll get today another above trend volume day solely due to quadruple witch expiration. With the open interest in the SPX options at strikes around current levels relatively small, it may be uneventful. The US$ is bouncing for just the 2nd day in…Read More

Category: MacroNotes