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Dollar Carry Trade!
A couple of months ago, I mentioned in this column that there was talk in the marketplace that the dollar could become a principal funding currency for carry trades if U.S. interest rates declined. Given the fact that interest rates at that time were two percent higher than they are today, it would appear now is a good time to reexamine this hypothesis.
Before the subprime interest rate melt down in the U.S., speculators were borrowing Japanese yen with interest rates in the sub-one-percent area. Then, for a healthy pick up, they would sell the yen and buy Australian and New Zealand dollars or even Turkish lire, Brazilian reals and Icelandic kroner to invest in these countries with high interest rates in the six-plus-percent area. That was then, before risk aversion kicked in, driven by fear, panic and any other kind of mental duress the financial markets succumbed to.
Back to now. The USD/JPY has fallen from 110 to 100 — a ten-percent increase in value in two months — and the Australian and New Zealand dollars have risen from 0.87 and 0.76 respectively to 0.94 and 0.82, making their percentage rises 13.8 percent and 10.5 percent. The reason the A$ has risen more than the NZ$ can be explained by Australian interest rates rising from 6.75 percent to 7.25 percent in the two-month period, while those in New Zealand have remained static at 8.25 percent. Obviously, not too many speculators are selling the yen with such a strong rise. So, which currencies if any are being borrowed or bought and then sold to fund the purchases of the high-yielding currencies? As the euro has risen from 1.4700 to 1.5900 this morning (a 8.9 percent rise) and the pound has gone from 1.95 to 2.0400 (a 4.6 percent rise) from its high two weeks ago, it is obvious the U.S. dollar was the weak currency vs. the other majors.
Is there any way we can find some proof that the dollar (which was the loser vs. these other currencies over the same time period) was actually used as the funding currency for those that invested in the A$ and NZ$, which both rose more than the euro and pound during the two-month time span. In examining the market data, there actually was a time period where this seems to be the case. During the month of February, the GBP started the month and ended the month at 2.0000 and the euro started and ended at about 1.5000. During this consolidation period the A$ rose from 91 to 93 (2.2 percent) and the NZ$ rose from 80 to 82 (2.5 percent). Therefore, this sideways move by the dollar could at least have been driven by investors buying US$ so that they could sell them and buy high-yielding currencies.
This was the assumption I wanted to investigate here and I am surprised that it actually appears to have been the case. This leads to the next question: can such gains — in this case with the A$ and NZ$ — happen first before the other major currencies adjusted to the change in direction that started the next spell of currency strength? In other words, can the gains be a precursor of such a move. In this case, the antipodean currencies do seem to have been the leaders in the short-term cycle of weakening and strengthening, indicating that the above supposition is as plausible as any other.
Having covered the before, and the now, let's look at the future. Could lower U.S. interest rates from the current 2.25 percent actually serve to support the dollar as the interest rate differential at 1 percent or 1.5 percent would become too attractive to turn down? Remember, those that do not have dollars to sell when they buy the high-yielders have to buy USD first before they can sell them as the front end of the FX swap, which serves to produce the spread benefit in the most efficient manor. From the cash flow view this seems to be a wash. When the dollars bought with, say, euros is then sold at the same time as the swap is put in place, does it actually have any effect? In this case, there would have to be more buyers than sellers of dollars for the dollar to strengthen. U.S. dollar-based investors interested in the trade would not have to buy the dollars; however, when they sell them at the front end of the swap they would then create a situation where there would be more sellers than buyers. Therefore, we would not be able to tell if the U.S. dollar was being used as a funding currency as it would weaken along with the current trend. If we think back to when the yen was the principal funding currency, we remember that the yen remained weak and tended to weaken, supporting this assumption.
With the A$ and NZ$ gaining between two and five percent more than the major currencies in the two-month time period it appears new carry trade positions are being put in place, despite the incredible volatility in the markets.
In the future, an increase in higher-yielding currencies followed by a lesser reaction in the major currencies may be an indicator of the end of the dollar's fall. On the other hand, this scenario may just add to the confusion about what is going on with the markets, only to become clear in the rear view mirror.
Stay tuned. I am trying to identify the trends before any market movement becomes a surprise.
— Laurence Hayward, Senior Advisor, SVB Silicon Valley Bank's Global Financial Services
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Wi-Fi Gone Awry
Plans for municipal Wi-Fi grids in major U.S. cities have ground to a halt, thwarted by unrealistic expectations and technological glitches. From Philadelphia to Houston, service providers like Earthlink have withdrawn from the projects after concluding that they could not be profitable. Some believe that municipal networks owned and operated by municipalities would be more sustainable because they take into account the quality-of-life benefits to citizens, such as free wireless access. As an alternative plan, San Francisco may team up with multiple nonprofits and companies to set up smaller Wi-Fi areas, especially in poor neighborhoods. (New York Times)
Virtual Campaigning
New social media technologies are helping presidential candidates stump virtually. SplashCast, used by Clinton supporters to launch a Web site, can build campaigns that can spread virally through the Web. Online ad agency Spot Runner has developed an Internet advertising platform that uses the Internet to allow candidates to run targeted ads on TV, radio and online, with a library of pre-produced political commercials covering a variety of issues. Ads can be turned around in a day or two, allowing campaigns to react immediately to issues. "Political advertising is moving toward microtargeting. It's democratizing the election process. Technology is becoming the great equalizer," says Rosabel Tao of Spotrunner. (VentureWire)
Bright Ideas
Southern California Edison Co. plans to build the nation's largest solar energy installation — an array of collector cells that could power about 162,000 homes, with some sites operational as soon as August. Florida utility FPL Energy LLC has also sought approval from the state to build a solar energy project in California. The company's proposed Beacon Solar Energy Project would involve more than 500,000 parabolic mirrors assembled in rows on 2,000 acres in the Mojave Desert. (AP)
Biotech Awesome in Austin
In recent months, central Texas-based life science companies have garnered about $500 million in venture capital. The formation of the Austin Technology Incubator's new Bioscience Incubator, the passage of Proposition 15 to create a $3 billion Cancer Research Institute, a new life sciences commercialization center in Georgetown and local medical schools are helping the life sciences and biosciences catalyze in the region. (Austin Business Journal)
Cancer Therapies Through Nano-cells
An Australian biotech company EnGeneIC says it has developed a "nano-cell" that can be used to directly deliver drugs to cancer cells. The company reports that the technique worked in primates and promises to reduce the amount of cancer therapies needed for treatment, while avoiding many of the harsh side effects of chemotherapy. The nano-cell relies on antibodies to dock on the cancer cell for targeted delivery. Researchers hope to begin human trials later this year. (Scientific American)
CFOs Power Up
Pharma CFOs are now the industry's "power forwards" concludes Ernst & Young (E&Y) after analyzing two global surveys. As companies shift focus from driving sales growth to managing returns, CFOs will have to be increasingly proactive. E&Y found that 92 percent of drug execs rated reducing costs as a major concern in their businesses, and over half depended on their CFOs to lead the charge. Nearly three-quarters agreed that CFOs will need to shift their time from low value functions such as defensive monitoring and reporting to focus on growth strategies that enhance business performance. (Ernst & Young)
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March 31, 2008
The Check is in the Mail
As various national news organizations continue to detail the rich stew of fraud and incompetence that has become known as the subprime mortgage crisis, we decided to check in on former colleagues on Wall Street to take their temperature. With 35,000 jobs gone and the likely disappearance of thousands more, the mood, as you might expect, is less than buoyant. We were pleased, however, to discover that the relentless creativity of these masters of the universe continues unabated. After all, these folks have enormous IQs, recently pocketed bodacious bonuses and they now have time on their hands. The invention which appears to be hitting the big time is an entity called a SPAC (pronounced "spack") or Special Purpose Acquisition Company.
A SPAC is essentially a blank check. The fact that promoters and the financial press unabashedly refer to SPACs as blank check companies should give any investor pause. (We wonder if they invented an investment vehicle that was referred to as a "Ponzi-type company", would anyone notice?) A SPAC raises money in an initial public offering with a plan to use the proceeds to make smart acquisitions that will increase in value. At the time of the IPO, investors have nothing of substance to consider other than a collection of smart managers and a hope that something wonderful will befall them. In 2007, there were 66 SPAC IPOs raising more than $12 billion. This represents 25 percent of all IPOs and, importantly, about $700 million in investment banking fees. SPAC strategies and IPOs are getting bigger and bolder.
One of the largest, Trian Acquisition Corp I, went public last month raising an astounding $920 million. Trian is one of the newer SPACs with a "broad industry focus, mirroring a newer approach taken by some other high-profile blank check companies," according to Investment Dealers Digest. In other words, they are not sure what to do with the money they've raised. Trian's 10-K does not reveal any of their secrets other than to state bluntly, "We are a development stage company with no operating history and, accordingly, you will not have any basis on which to evaluate our ability to achieve our business objective." The team does bring competitive advantages and in the 10-K they cited their, "Intense focus on due diligence that seeks to identify key value drivers and significant risks." We suppose this means that, given their investment acumen and their wealth of experience as operating managers, they would never, ever consider investing in a venture such as Trian Acquisition Corp I. This logical inconsistency is reminiscent of the dot-com days of Henry Blodget et al. where it was commonplace for sell-side security analysts to recommend to clients stocks that they personally held in complete contempt.
Well, the good news here is that SPACs have hit the big time. The NYSE is lobbying for permission to waive their normal listing rule requiring three years operating history to accommodate new SPACs. And for issuers, that listing should be a breeze. You see, one of the benefits of having no operations is that the Section 404 review under Sarbanes-Oxley is a cakewalk. The high costs of preparing an S-1 are also eliminated. Most SPAC S-1s contain fewer financial details than your average PTA budget meeting. Bulge bracket firms like Goldman Sachs are getting into the game and are expected to muscle the small fry aside as the market heats up. The Wall Street Journal pointed out that Goldman's entry into the market will add "legitimacy to a structure that was considered suspect by Wall Street." (Too bad Goldman's entry into the subprime mortgage market couldn't somehow make that more legitimate.) According to Tom Gallagher, president of Legend Merchant Group and a SPAC impresario, the asset class is following a "biological model of exponential evolution." Is that biological, as in the way the Ebola virus mutates and destroys everything in its path? Call us old-fashioned, but we are still puzzled by a regulatory environment where you can't take public a profitable $100 million operating company, but you can staple a batch of résumés to an SEC Form S-1 and raise $900 million.
Oh, For A Return to Normalcy
Fear and loathing continued to reign in the short-end of the money markets last week. The market breathed a sigh of relief when the 4-week bill returned to a more normal yield of 1.27 percent from one-half of one percent. That relief lasted until we all remembered that this rate was 100 bps under the target Fed Funds rate. No matter. The Fed Funds as traded closed the week to yield 25 bps — some two percent under their own target. Some financial pundits are writing about there being "light at the end of the credit crisis tunnel" It must be a dim light. Many posit a revival of mortgage market liquidity via a combination of massive government purchases at steep discounts that will trigger all that smart private money sitting on the sidelines waiting for the bottom.
Chairman Gentle Ben goes back to the hill this week and will no doubt get many questions about the Bear Stearns affair. We can hear it now, "Why did you put up $30 billion for this investment banking deal when my aging mother can't even refinance her mortgage to buy that new Lexus she wants?" We think Chairman Bernanke need only explain that he was merely preventing another foreclosure — albeit quite a large one.
The final revised revision of Q4 GDP was unchanged at 0.6 percent real growth. The Fed's favorite inflation measure, PCE Core Deflator (ex-food and energy), was muted, showing only a two percent rise last month. For those of us that insist on consuming food and driving automobiles every day the number was a more daunting 3.4 percent. Consumers — at least those contacted by the Michiganders last week — are positively morose. The confidence index dropped to 69.5 the lowest level since 1992. We're at a loss to explain why. Perhaps it is the continuing jobless claims, which climbed above its 12-month moving average. Or maybe it is the price of gasoline, which now officially costs as much as a gallon of milk in my neighborhood. Then there is the fact that the contest for the White House has devolved into a popularity contest similar to the election of a high school student body president. But, take heart, the U.S. consumer is a tough breed. As soon as they find something to borrow against we're certain they will be back out shopping again. In the event, yields moved up 13 to 18 bps across the curve except the short-end where the moves were 73.5 bps and 32.9 bps for the three-month and six-month bills respectively.
End Note
According to the Associated Press, a federal appeals court rejected a New York statute requiring airlines to provide food, water, clean facilities and fresh air to passengers trapped in a plane delayed on the ground. Our sources told us the first law in the nation outlining the rights of airline passengers stuck in these circumstances was modeled on the minimum requirements for the humanitarian treatment of inmates in the state's penitentiary system. That's all we have to say about that.
— Jim Anderson, Editor
Investment Strategy Outlook is published each week to highlight issues we hope you find relevant and topical. The views expressed in this newsletter are solely those of its authors and do not reflect the views of SVB Asset Management, Silicon Valley Bank, or any of its affiliates.
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Fed To Buy Mortgages Next?
Forget lower interest rates. For the Federal Reserve to keep the financial markets from imploding it needs to buy troubled mortgages from banks and securities firms, say the world's biggest Treasury investors. Even after cutting rates by three percentage points since September, expanding the range of securities it accepts as collateral for loans and giving dealers access to its discount window, the Fed has been unable to promote confidence. The difference between what the government and banks pay for three-month loans almost doubled in the past month to 1.69 percentage points. (Bloomberg)
Consumer Sentiment Lowest since 1992
Growing concerns about the economy, unemployment and inflation have pushed consumer sentiment to its lowest since 1992, according to a Friday report from University of Michigan/Reuters. The U.S. consumer sentiment index fell to 69.5 in March from 70.8 February. "A recession has occurred whenever the sentiment index has declined as much as it has fallen during the past year, including the recessions occurring from the mid-1950's to the early 2000's," said Richard Curtin, the director of the survey. Among respondents, 86 percent said the economy has already slipped into recession. (MarketWatch)
GDP Went to 0.6 Percent in Fourth Quarter
The U.S. economy downshifted abruptly in the fourth quarter, growing at a 0.6 percent annual rate, the slowest pace since late 2002, the Commerce Department estimated Thursday. The 0.6 percent estimate for gross domestic product, unrevised from the previous two estimates was expected. By contrast, GDP grew at a 4.9 percent annual rate in the third quarter. The final estimate for fourth quarter GDP contained little that was new, aside from fresh data on corporate profits: After-tax profits from current production fell $37.9 billion or 3.3 percent quarterly, to an annualized $1.11 trillion. Net cash flow fell $55.7 billion, or 4.4 percent. (MarketWatch)
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UBS Cuts Values of Failed Auctions
Last week, as state officials begin investigating the auction rate bond market, UBS announced it would cut the value of auction debt held by its customers by about 5 percent. Failures in the auction rate security market have pushed interest costs for some borrowers as high as 20 percent and the rate of failures show no signs of slowing. UBS informed its clients of the reductions Friday, March 28. Michelle Creeden, a spokeswoman for the firm, said the move was "the right thing to do" and "given current market dislocations, this is the next logical step for any committed wealth manager." (Bloomberg)
Two-Year Treasuries Rally Towards 1.5 Percent
Leading forecasters of Treasury yields say it's too early to call an end to the rally that propelled U.S. bonds to their best annual start since 1995. Yields on two-year notes will decline to 1.50 percent by July from 1.65 percent last week, according to Goldman Sachs and Barclays Capital. Demand for government debt may increase as investors shift their attention from the more than $208 billion in write-downs and credit market losses over the past year to the likelihood that the economy is already in a recession. Treasuries of all maturities have returned 4.2 percent this year. (Bloomberg)
Fed Gets Overseas Support as Ammunition Runs Low
Federal Reserve Chairman Bernanke has shouldered most of the burden of saving the global economy and financial markets to date. He may be about to get more help. With the credit crisis entering its ninth month, Bank of England Governor Mervyn King and European Central Bank President Jean-Claude Trichet are on the verge of new steps to spur lending and increase liquidity, say economists at Lloyds TSB and Royal Bank of Scotland. Interest rate cuts may be next if the crisis persists. "We're inching closer to the great global monetary easing," says Joachim Fels, economist at Morgan Stanley in London. (Bloomberg)
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