Piponomics: Studying the Love Child of Forex and Macroeconomics

It seems like the "economic term of the year" is "interest rates". Could the Fed raising rates 13 straight times possibly have something to do with it? (Yes, the Fed will raise rates later today to make it numero 13.) Maybe just a tad.

But what is the press is going to write about when the Fed decide to stop hiking rates? They got to write about something. The world always need their insatiable fix for drama. Britney Spears decided to get pregnant and disappear from the world, so Paris Hilton was finally able to come off the bench and take her place. "Interest rates" was Britney Spears. What is going to be Paris Hilton? Hmm, how about "trade deficit"?

Trade deficit? Why I do believe that does have a sexy ring to it...traade defiiciit...yes I believe we just might have ourselves a winner folks. Plus it's worked in the past. Trade deficit. "That's hot."

Here's the story the media will sell:

 

1. Trade deficit is bad (sell USD)
2. Trade deficit is unsustainable (sell USD)
3. Trade deficit > TIC data = BAD (sell USD)
4. Trade deficit < TIC data = GOOD but unsustainable (buy USD)

I might be jumping the gun here. Interest rates is still the "it" term right now. But I'm a futurist. I'm already looking for next thang.

So I'm reading an article yesterday trying to explain the slaughtering of the US bulls yesterday and one of the cited reasons was because of a comment from Chinese official economist Yu Yongding who says that China and other Asian central banks must come up with a plan to slow the rate of accumulation of USD and to eventually cut their holdings.

Oh no! If China is planning to unload USDs in the future, then we better unload USDs! Right?

This is the same dude who late last year was quoted as saying the Chinese central bank had been selling USDs, only for him to clarify later that he was merely referring to the slower rate of accumulation of Treasuries by China reported in the US TIC data.

Let me repeat what he says: "...China and other Asian central banks must come up with a plan to slow the rate of accumulation of USD and to eventually cut their holdings."

It sounds like to me they don't even have a plan yet.

How slow do they plan to slow the rate of accumulation of US Treasuries? Reduce it by $10 million (drop in the bucket)? $100 million? $1 billion?

And how long does it take to create a plan that's fully agreed upon to be actually executed? 1 month? 6 months? 1 year? How about 5 years? Or 10 years?

I don't think they plan to unload anytime soon and it goes back to the trade deficit.

China is an export-dependent country. They make all this stuff but their own citizens can't afford most of this stuff so they have to sell to other countries who have money to buy their stuff. So who buys most of their stuff? How about the United States. The exports to the US account for 30% of China's total exports. China is a US-dependent country. It's not just China though, it's also the other Asian countries as well. Asia is a US-dependent continent?! Go figure.

My point is US is Asia's best customer. Until you can find a better customer, you treat your best customer like a king. Nobody will buy as much from them as the US so it's in their best interest to continue to make sure our TIC data covers our current account.

As long as US keeps importing from the export-dependent countries AND until a decent sized consumer market develops in Asia, which could take 5-10 years, it is in their best interest to maintain the existing relationship—buying US paper.

If U.S. goes into a recession, their consumers will stop spending, which means they'll stop buying stuff...stuff that comes from China. If that happens, China (and other Asian countries) will go in a deeper recession than the U.S. Not good. Would you want your sales to be slashed by 30%?

Is this trade deficit sustainable? Well if it ain't, that sucks for Asia.

So are the dollar bears is just trying to find an excuse? If you chart the current account against the dollar index you would be hard pressed to see any relationship.

Check out this article written on Dec. 8 for more food for thought.

The October trade deficit hit an all-time high of $68 billion.

But it was matched by an all-time high of $107 in net foreign capital flows.

I do have to reveal most of the buying were from European and minor Asian central banks.

Notably absent from the increase however were the central banks of China and Japan, who until now were reliable and largest creditors of the US debt.

The chart below shows that the trade deficit has been covered by foreign capital flows into US paper for the last 5 months.

Will foreign capital flows continue to exceed or at least match the trade deficit?

Check out what Bernanke thinks.

He also gives a pretty good explanation of why we have trade deficits.

This is a very interesting article and could be a big story for this year,
http://www.dailykos.com/storyonly/2005/12/27/115725/53

Essentially ALL oil is currently traded in US dollars, since there are only two markets, NY and London, where one can buy or sell oil. Everysingle barrel of oil is bought and sold in American dollars.

Apparently, this is changing...

"A shift away from U.S. dollars to euros in the oil market would cause the demand for petrodollars to drop, perhaps causing the value of the dollar to plummet.."

The plot thickens when the author connects this upcoming change with the Fed's decision to stop reporting M3 supply and suspects the main reason is because they fear the amount may go down drastically.

The business press and many financial analysts provide the reassuring message that the flow of capital to the US substantially exceeds the amount needed to finance the US current account deficit, and that that inflow is coming primarily from private investors who are attracted by the strength of the American economy. Apparently this seems more of a misinterpretation of data.

Check out this blog article, http://economistsview.typepad.com/ec..._feldstei.html

A proper interpretation of the data reveals that the source of capital inflows is primarily foreign governments, not foreign private investors.

Which means capital inflows are from foreign countries who buy to manipulate their currency rather than their belief in the strength of the US economy.

The Carlson-Craig-Melick estimates of probabilities for the next two meetings of the Federal Open Market Committee make 25 basis point a lock on January 31, but check out the probability for March...it's a favorite at 60%

killer graph man. do you know how they calculate the imp probability? i know it's based on the fed fund futures price, but i always wondered what the calculation was...

If you click on the "Carlson-Craig-Melick" link there's a paper that describes the estimation technique.

This is from the "Fed Funds Reference Guide" from CBOT:

Fed Funds Futures and the Probability of a Fed Policy Shift

Perhaps no single interest rate is watched more intently than the fed funds target rate set by the Federal Open Market Committee (FOMC or, popularly, the Fed). Perhaps, too, no single financial policy decision carries more weight in all corners of the financial world than an FOMC decision concerning whether to raise, lower, or leave untouched the fed funds target. In the weeks immediately prior to a Fed meeting, the financial media will carry comments to the effect that fed funds futures prices indicate, for example, a 43% probability for a 25 basis point (bp) decrease in the fed funds target rate.

These people are working from simple probability math, and you can do the same thing. Consider the market situation on March 27, 2003. The next FOMC meeting was scheduled for May 6. Also, for some weeks, at least some commentators had been saying the Fed would be likely to lower its already low target rate from 1.25% to 1.00%. Of course, the March 18 meeting had come and gone with no change in the target.

On March 27, the May fed funds futures contract was trading at a price of 98.86 which implied a fed funds rate of 1.14% (100 – 98.86). Using a standard probability equation, you could have used that implied rate to estimate the probability that the Fed would either lower the target to 1.00% on May 6 or leave it unchanged at 1.25%.

1.25% * (6/31) + [1.00%p + 1.25%(1 - p)] * (25/31) = 1.14%

Here p is the probability the Fed will lower its target rate 25
bps, (1-p) is the probability the Fed will leave the target unchanged, (6/31) is the fraction of the month during which the target is known to be 1.25%, and (25/31) is the fraction of the
month during which the target is unknown.

Solving for p, you will discover that in this case p equals 0.5456. That is, this exercise predicts a 55% probability that, given the market situation on March 27, 2003, the Fed would lower its target rate 25 basis points at its May 6 FOMC meeting and a 45% probability that it would leave the target unchanged.

Check out this chart. You can see there's a pretty tight correlation between the dollar and crude. When the black stuff rises, the dollar falls.

The black line represents crude oil futures and blue represents the US $ Index (inverted).

very nice! thank you sir. i just made a neat indicator that shows the probability live on the fed funds futures chart...

Oil is the new black Crack

Some people call oil black gold. I call it black crack. One can live without gold, but if you're a crack addict, you can't live without yo crack yo.

You wonder why oil cost so freakin' much? Thar chart from uh "Chart of the Day" shows why oil will probably be never cheap again. It shows the four biggest oil "addicts" in the world. Everybody is pretty much is hooked but if you look closely, it's pretty obvious who is biggest addict is. The United States of America off course. The closest oil fiend is China who might even dethrone US in the future.

This chart shows the relationship between the price of crack err oil versus the US dollar. The dollar is flipped upside down so the relationship is inverse. All this means is when oil price rises, the dollar weakens. And vice versa.
But does US seem to care about the strength of their currency? It doesn't seem like it. As long as they get their fix, it's all gravy baby.

Just giving life back to a good old post... This forum has been quality from day 1 I started reading it, way before I joined.

It is a shame that much of what is discussed now has to do with ema crossovers.