The First Shots

For some time, Macro Man has held the view that one of the primary second-order risks of the current financial crisis and the concomitant recession would be a broad-based rise in protectionism and beggar-thy-neighbour policies.

To be sure, for the likes of China and other Asian mercantilist nations, such activities are meat and drink for economic policymakers. But yesterday saw the first shots fired in the West, where there were not one, not two, but three separate currency comments from policymakers. It reminded Macro Man of nothing so much as a fight scene from the old Adam West Batman series:

WHAM! Phiipp Hildebrand of the SNB said that with the zero-interest bound rapidly approaching, the bank would consider “unlimited” currency intervenion to weaken the CHF. Cue a predictable rally in EUR/CHF:

POW! It seems as if France has moaned about currencies every year since the late 1960’s Bretton Woods balance of payments crisis. They continued the streak in style yesterday, as FinMin Christine Lagarde rapped the BOE on the knuckles for doing nothing to defend sterling. (The UK Treasury issued a swift two-word rejoinder, the second word being “off”.)

“Separately”, a G7 source (codename: Fer a Cheval Bleu), mentioned that G7 would dicsuss sterling weakness at next month’s meeting.

BAM! Yesterday was quite an interesting exercise in game theory, as there was an enormous ($6 billion) option expiry in USD/JPY at 10 am New York time. The strike price was 90.00, and and expiry USD/JPY was trading at…..90.05. The thinking in the market was that the option short would need to buy $6 billion after expiry, and were leaning long as a result. When the institution in question pulled the bid at 10.01, a 3% plunge down the elevator shaft swiftly ensued, taking USD/JPY down to its previous low of 87.10.

Intervention rumours swiftly ensued, though USD/JPY subsequently squeezed higher along with US equities. But still, it would be quite a statement for Japan to intervene in currency markets in week one of the Obama administration. Such a statement, in fact, that the presumptive Treasury Secretary Geithener made a comment yesterday (admittedly not targeted at Japan specifically) reiterating the US preference (or demand, depending on your perspective) for flexible, market-determined exchange rate regimes for major trading economies.

The list of countries that prefer a “competititve” (economist-speak for weak) exchange rate is a long and growing one, while the list of those wishing for a stronger local currency is rather short indeed. Something tells Macro Man that we haven’t seen the last of this issue….

Elsewhere, bond bears now have their chance to shine. Equities have quite going down in a straight line (the SPX has rallied on 75% of the last 4 trading days!!!), and long bonds have broken a fairly key support line. If the bond bubble is gonna burst (say that five times quickly after a few beers!), the ducks are lining up for the first shot to happen now.

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