On FX

On October 25 I wrote about what, at the time, looked like an overvalued EURUSD (it was 1.3950). Zero Hedge had an article attributing the strength to ongoing capital repatriation by EU (primarily French) banks. My words:

As long as there is Euro repatriation, the EURUSD will remain overvalued. It’s about day-to-day demand, not the backdrop of the news.

I can’t predict how long this will take to wash out. My guess is under a month. I think the Euro is a big short. I can see EURUSD = 1.3000

I covered that up Friday morning. (Note: This was a nice win, but, alas, there is “ugliness” on other parts of my sheet). I went for a long walk feeling pretty good about being disciplined.

About a mile into the woods I started having second thoughts. I turned around, came home, made a call and spent a good chunk of the realized FX gains buying expensive puts on the Euro. Fuck discipline.


Let me try to explain my schizophrenia. On one hand I don’t think the EU is going down without a fight. I think there is a decent chance that some additional steps are announced in the next few weeks that will give the appearance of an all out effort to save the Euro Zone. Something significant could come from the IMF. We could get news from the US Treasury in the form of a draw down of the Exchange Stabilization Fund. There could also be additional measures by the US Federal Reserve. The ECB could announce un-sterilized bond purchases (Euro QE#1). There are a number of other possibilities.

The market is short Euros (in big amounts) against everything from Yen, USD, Sterling, and Kroners. This is a very crowded trade at the moment. I hate crowds. That was the reason for the AM bailout of a long held position.

But there’s another possibility. We could see the whole Euro experiment unwind by March. The Fed can’t really do a thing. Their hands are tied. Bernanke has already said he would not bailout the EU. If he reverses himself he will lose his credibility, and his job (He knows that). Tim Geithner can’t do much with what is available to him. The ESF has no size behind it ($105 billion). The IMF will probably do something, but the most it could bring is a few hundred billion Euros. If the ECB goes into the QE business the rating agencies and the market will retaliate. My bottom line is that no one has a bazooka.

Consider the news of the past week in Europe. Hungary is falling apart in an ugly way. In Berlin and Bern there are significant political scandals (Wulff and Hildebrand). Important elections are coming in France. The whole area is rapidly moving into recession. The rating agencies will be downgrading core countries over the next month. The refinancing requirements of the Sovereigns and their banks can’t be accomplished in the current environment. We may have a failed auction that tips the scale to chaos.

What is one option that is not now being considered and would have a beneficial affect on the EU? Simple. Devalue the currency by 20%.

Far fetched? Impossible? Maybe. But that is exactly what happened on 9/22/85 when then Treasury Secretary James Baker engineered a significant devaluation of the dollar with the Plaza Accord. To achieve the desired devaluation the global central banks sold dollars. I know, I was strapped to a seat for a week.

There are no central banks that want to do this. It would hurt the US, Japan, UK, Brazil, Korea and China. But they don’t want an implosion of the EU either. A significant devaluation would be a big boost to short-term economic prospects for the EU. It would do little for the solvency/funding problems. But it would stimulate growth and create some jobs. Without that, the EU is dead anyway, so devaluation is not out of the cards.

A compelling argument for a coordinated devaluation is the Swiss Franc. The Swiss National Bank engineered a 20% devaluation last year. With a “little help from its friends” the ECB and the French/German central banks could pull the same maneuver. Desperate times require desperate measures.

What are the odds of a coordinated devaluation of the Euro? Not high, is the answer. But it’s not zero either. It doesn’t mean much if a low rent blogger brings up stuff like this. It would, however, be significant if one of the EU papers ran an editorial along these lines. Better yet, one of the ‘deciders’ could say something about how “desirable” a cheaper Euro would be. The odds of something like that are pretty high in my book. It wouldn’t take much talk to get the markets riled up.

So I bought those puts. Like most puts, they’ll likely expire out of the money. But there is a 1 in 5 chance they will come into the money big time. If they do, I’ll have an another FX win, but the rest of the sheet will go deep into the red…..

Red Alert on the CHF?

I’m not satisfied with the responses by Philipp Hildebrand. But the Swiss newspapers are all giving him a break. The Swiss love their head of the SNB. He was a swimming champ. He’s good looking, and so is his wife. It seems, for the moment, that his conduct will be swept under the rug.

But, behind the scenes, Hildebrand will remain under attack. There is a dark political angle to this story; powerful people in Switzerland want Hildebrand out. They blame Phillipp for the mishandling of the currency intervention that led to a $21b loss for the SNB. I think these same powerful people are afraid that the current SNB policies could deliver a very damaging blow to the country.

Swiss foreign reserves rose to nearly CHF 260b (50% of GDP) at the end of December. That’s up significantly from November. In addition to these published reserves, the SNB has stated that it has used options to maintain the EURCHF above 1.200. So we really don’t know how big an exposure the SNB has.

If one more shoe drops on Mr. Hildebrand (or his wife), he will be out. That would immediately give rise to the question of whether the peg will be maintained. The real reason that Hildebrand is in such trouble today is that he was responsible for the intervention policy that led to the dangerous reserve accumulation. Given that, it’s likely that his successor would not be so willing to follow the same path. A new SNB chief would, at a minimum, have to reconsider the intervention/peg policy.

If Hildebrand is forced out I think the SNB would have to step up and absorb a few hundred billion addition Euros. I don’t think they can do that. Something like that could bust the SNB.

Please don’t read this as a suggestion to speculate on the CHF. The scenario I describe is not the likely outcome. I am suggesting that one pay closer attention to the CHF crosses. If the EURCHF backtracks close to the 1.2 level there is going to be fallout across all markets.

The EURCHF closed at 1.2147 on Friday. That’s a two-month low. I (and a bunch of others) made note of this close. I’m sure the folks at the SNB did too.