Ralph Shell @ 12:51 PM, Thursday November 18 2010
Fearing the worst from Bernanke's QEII, currency speculators aggressively shorted the USD versus all other currencies. According to our COT analysis the short USD position reached a peak in the OCT. 19 report at 282,947 contracts. We expressed concern about the crowded short position in our note on Nov. 9 entitled "Are There Too Many USD Shorts?" Despite concern about the European debt issues, the specs retained their big USD shorts, which totaled 268,712 in the Nov 09 COT report. For comparison purposes, last year in late November, when the USD was trash, and the euro was on the top side of 1.50, the total short USD long another currency was 270,220 contracts. (We calculate these positions using futures plus the delta adjusted option positions.)
This week, as the headlines about the troubled Irish banks have grown larger, and the Dublin Hotels and pubs have filled with an aggregation of international bankers, the specs headed for the exit. During the last two days the total open interest in the A$, pound, C$, SF, Euro and the Yen have gone down by 51,890 contracts. Fearing runs on other countries debts and currencies, bankers are diligently working to build confidence in the euro and their banks.
With the markets cleaner after the specs recent exit, there is a chance the USD can now weaken. Granted there are problems with the rest of the PIIGS, but if the Irish debt issue is successfully diffused, this may quell the bond and currency traders nerves.
Today the global equity market, pleased with an anticipated positive solution in Ireland, and propelled by the successful GM IPO, are quite strong, currently up 186 on the Dow. Overlooked for the moment is the dismal reception to new issues in the US municipal bond markets.
This week California, confronted with a budgetary short fall of $25B through June 2012, tried to sell $10B "revenue anticipation" notes. Investors, no doubt frightened with the reelection of Governor Moonbeam and the passage of an environmental proposition that will hastened the exodus of business from California, took only 60% of the issue. An article in Seeking Alpha by Douglas Borthwick entitled PIIGS vs. States' USD 5-Year CDS offered these observations about the US states debt:
" Interestingly, while Ireland contributes only 1% of Europe's GDP, California contributes 13% of the US GDP. The markets are well aware that the Build America Bonds program rolls off at the end of 2010. Before the signing of that program by President Obama, we note the 5Yr USD CDS in California was trading at around 458. Currently, Portugal is trading at 408. This month is seeing a wave of activity in the Municipal market as States scramble to raise money ahead of 2011.
Given the recent change in leadership in the Congress and the ascent of the 'Tea Party,' we doubt whether Congress will extend the Build America Bond plan with any degree of haste. CDS spreads for US States will likely rise considerably above their current levels, at that point eclipsing those of the PIIGS that the market is currently focused on. We also note that current 5-Yr USD CDS indicate Illinois and California have a higher expectation of default than Spain; while Michigan, New Jersey, New York and Nevada have a higher expectation of default than Italy. At some point, given the likelihood of Europe coming to Ireland's rescue, we have high expectations that the States may soon eclipse the PIIGS in terms of default risk. This tipping point will fuel the rally in the EUR versus the USD that we expect going into 2011."
Yes the Build America Bonds, part of the $787B stimulus package, which provides a 35% subsidy on the interest to the issuer was very popular with states. Critics point out, however, that they did not Build America, but merely allowed the bloated state bureaucracies and mismanagement to continue, and for that reason extension in its present form is unlikely.
We are not ready to declare the euro debt problems solved and the US muni debt problem, the next major market mover, but the markets have shed a lot of spec longs. Perhaps it is best to observe news developments and see how the market reacts to them. At the moment we seem to be focused on which economy will encounter the fewest difficulties. Any chance we will get some good news to trade?
Author: Ralph Shell - ForexRazor Analyst - Graduated from a small Ohio liberal arts college. Graduate studies in economics and history at Duke University. Ten years experience trading cash commodities in domestic and export markets. Former commodity analyst with Merrill Lynch in Chicago. Member of and floor trader at the Chicago Board of Trade for 18 years.