Strategic Currency Briefing

Outlook

We get the last FOMC minutes today and some folks will want to examine them in minute detail, but we bet all the action lies in the oil price story. Russian sources told the press some interesting nuggets (and the Russian Energy Ministry spokeswoman confirmed the information is accurate). First, Russia predicts the acceptable price is $45-50—this is the number that will balance the market, and do it faster than non-interference would do by about six months. Anything higher will goose the shale guys into raising output. "Now there is discussion of how long production will be frozen and ways to monitor the agreement," one of the sources said.

"A freeze without Iran is being discussed. At the moment we don't see tough conditions (from others) for Iran to join," one of the sources said. Russia thinks Iran is increasing exports with low-hanging fruit (oil from storage) and will take a long time to get to the target of 4 million bpd in exports. Besides, the Doha deal will target output, not exports. Doha will include 17 countries, including a few that used to belong to the Soviet Union. Russia itself wants to deepen cooperation with OPEC without actually joining.

We continue to believe Doha is a very Big Deal and will be a game-changer. Outcomes may include a rise in capital spending once companies have a better grip on costs. Another might be a fall-back in alternative energy initiatives, since it’s oil over $100 that gives them much of their momentum.

What does it mean for the dollar? The conventional wisdom is the inverse correlation—oil up, dollar down and vice versa. As we have complained too many times to count, this is a self-reinforcing idea that is fairly dumb at its very core, but never mind. We shall see if it works this time.

The debate about negative rates continues to simmer away on the back burner. The WSJ has a story today pointing out that near-negative rates actually raise risks for those condemned or choosing to invest in this sector. “The 10-year German yield fell below 0.1% Tuesday, moving closer to the all-time low closing yield of 0.073%. The yield has fallen around half a percentage point since the start of the year, with even larger declines recorded for longer-dated bonds. As a result, German bonds overall have returned 4.1% so far this year, according to Barclays indexes. Given the German DAX is down more than 10% year-to-date, that counts as a big result.

“But investors shouldn’t feel too comfortable. As yields decline, the margin for investment error shrinks drastically, as there is no cushion available to absorb moves in price. At a yield of 0.09%, more than 11 years’ worth of income would be wiped out if the 10-year bond drops in price by just one point. Yields wouldn’t even have to rise that much: a move one point lower equates to only a 0.1-percentage-point rise in the yield, to 0.19%, according to Tradeweb data.”

And it looks like this year could run parallel to last year. See the chart. By April 20, 2015 investors were up 4.5%. But by June 10, all of those gains and more had been wiped out, with the market down 2.2%.” Buying bonds at low yields can wipe you out if inflation and growth pick up. “A bond with a negative yield, if held to maturity, is like an expensive piggy bank that must be smashed to retrieve the cash inside. The German bond rally has delivered gains. But it has also left investors picking up pennies in front of a steamroller.”

Yesterday we wrote about bank leverage being (possibly) still dangerous. But leverage is not the only thing and leverage in US banks is not the only source of danger. What if some big European (probably German) banks take a big hit on holding bonds—which they are supposed to do as reserves and collateral?

Risk appetite may be on a new roll because of Doha, but some structural issues can still jump up and bite us on the rear-end. Here’s a shocker—Doha is more important than the US presidential candidates.

Fun Tidbit: The new Treasury rules on inversions is excoriated as a politically motivated and illegal move by the President in the WSJ, with a slant so steep it makes your hair hurt. The FT ranges more widely (and fairly) over the issues and quotes a professor who says “… the Treasury was right to eliminate what amounts to an unfair advantage for multinationals. ‘You shouldn’t have one set of rules for offshore companies and a different set of rules for others.’” Be careful what you read.

		Current	Signal	Signal	Signal
Currency	Spot	Position	Strength	Date	Rate	Gain/Loss
USD/JPY	110.44	SHORT USD	WEAK	02/04/16	117.57	6.06%
GBP/USD	1.4107	LONG GBP	WEAK	03/31/16	1.4371	-1.84%
EUR/USD	1.1354	LONG EURO	WEAK	03/11/16	1.1094	2.34%
EUR/JPY	125.40	LONG EURO	STRONG	03/29/16	127.24	-1.45%
EUR/GBP	0.8048	LONG EURO	WEAK	03/11/16	0.7759	3.72%
USD/CHF	0.9601	SHORT USD	STRONG	03/11/16	0.9877	2.79%
USD/CAD	1.3169	SHORT USD	STRONG	02/01/16	1.4031	6.14%
NZD/USD	0.6790	LONG NZD	STRONG	02/01/16	0.6478	4.82%
AUD/USD	0.7551	LONG AUD	STRONG	01/25/16	0.6980	8.18%
AUD/JPY	83.39	LONG AUD	STRONG	03/03/16	83.57	-0.22%
USD/MXN	17.7344	SHORT USD	STRONG	02/23/16	18.1208	2.13%