Key News

• The global economy should move toward a multi-currency reserve system from one dependent solely on the dollar and there should be greater use of the IMF and its unit of account, the Special Drawing Right, a think-tank study proposed on Friday.

This decade will certainly be one of transition. We do not expect a big bang, but a long, gradual process of incremental change and adjustment," the authors said, adding that dialogue between the developed and emerging economic powers was essential to revamp the system. "There is an argument for moving towards a multicurrency reserve system in line with the multipolar world, as well as expanding the use of a supranational currency such as the Special Drawing Right." The SDR's value is based on a basket of four key world currencies, currently the euro, yen, sterling and dollar. (Reuters)

• RECENT renewed American calls for China to revalue its currency have so far fallen on deaf ears. China has rejected accusations that America's huge trade deficit with it is caused largely by an artificially weak yuan, which has been pegged to the dollar since July 2008. Economists point out that an appreciation of the yen did little to help reduce America's trade deficit with Japan in the 1980s. But the yuan is unquestionably undervalued. Our Big Mac index, based on the theory of purchasing-power parity, in which exchange rates should equalise the price of a basket of goods across countries, suggests that the yuan is 49% below its fair-value benchmark with the dollar. (Economist)

Quotable

Come sit beneath the tariff walls
Among the scuttling unemployed,
The rodent pack; sing madrigals
Of Demos and the Cyprian maid
Bewildered by the golden grain,
While ships with peril in their hulls,
Deploying on the lines of trade,
Transport the future of gangrene.

                            The Economist’s Song, Stanly Kunitz [The Collected Poems]

FX Trading – Hodgepodge

US vs. German Yield Spreads – Tracking on the recent dollar index rally…

This from the Financial Times this morning:

Tremble: Brussels’ bureaucrats have sharpened their pencils. The European Commission wants several countries to explain how they will cut their budget deficits (so does everyone else). Eurozone capitals, meanwhile, argue over whether to bail-out Greece or bring in the International Monetary Fund. Markets are drawing their own conclusions. The combination of the eurozone’s fixed exchange rate, gaping deficits and skittish capital markets looks like the makings of an old-fashioned emerging markets debt crisis. That being so, it makes sense to look at a classic metric of debt vulnerability: rollover risk.

This measures how much and how often borrowers need to refinance maturing debt in the capital markets. Shorter average debt durations mean more frequent visits. Worryingly, EU countries have almost doubled their amount of short-term debt since 2007, according to Standard & Poor’s, to about 11 per cent of the total outstanding. Clearly, it can make tactical sense to borrow at near-zero interest rates. But rolling over such debts, worth more than €800bn this year, also increases the chances of a blow-up.

No wonder everyone is hiding in German bonds. This rush to a European safe haven has pushed yields on the 10-year German bunds lower; it has resulted in a significant widening of the spread in favor of US 10-year Treasury notes.

In the charts on the next page we compare this spread to the US dollar index chart. Notice as the US-German spread started widening in late November/early December 2009, it coincided nicely with the rally in the US dollar index?

US 10-year Note Yield (black) vs. German 10-yr Note Yield (red) Daily:

US Dollar Index Daily:

Is it still all one market?

The correlations among the various asset classes continue to be tight, though we are seeing some changes. Today with quadruple witching upon us, we could find out if past correlations are still in play.

Below is a chart comparing the S&P 500 index (red), Australian $-US dollar (black), and crude oil (green at the bottom):

Stay tuned.

Have a great weekend.