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2 Oct 21 2010 @ 10:42am by Matt Smith in Economy, Global Energy, risk management

The Dreaded Greenback and The Danger (Mouse) Faced

Although currencies are one of the key ingredients on the burrito, they are treated somewhat more like a garnish (salsa or cheese) rather than a staple (meat or beans). But no more I tell you! For today we swing the spotlight onto currencies, and we do this through the villain that is Baron Greenback (aka the US dollar) from the cartoon Danger Mouse. So let’s take a look at some of the key battles that are currently underway for the big bad Baron with some of its (arch-enemies) counterparts:

He’s the greatest, he’s fantastic,
Wherever there’s danger he’ll be there…Danger Mouse!

First up is one of Danger Mouse’s colleagues; Colonel K (Japanese Yen). The colonel is a stalwart, hence a good comparison to the Yen, which has just reached an amazing 15-year high versus the terrible Toad. Yen strength is due to its appeal as a safe haven – Japan’s economy is more like a boring bond than a volatile equity; even though interest rates may be negligible in Japan, fears about the European and US economies have left investors choosing to diversify into the Yen. Even though interest rates are less than 1% (on 10yr Japanese Government Bonds), in a deflationary environment, which Japan’s been in and out of for years, the real interest rate is greater than this.

This is Penfold. Codename: The Jigsaw, because when faced with a problem he falls to pieces. 

Next up is Penfold, the pint-sized peril (the Australian Dollar), against which the Baron appears to have met his match…..as the two currencies are now at parity. The Aussie dollar has had a bonza run in recent times, as the Australian economy has been stoic through the recent global recession due to demand from China for its natural resources such as iron ore and coal. The country is now seeing economic growth at its fastest pace in three years, and has raised its interest rate to 4.5% in the past year, making the currency an even more attractive destination.

A secret agent so secret that even his codename has a codename. Yes, Danger Mouse! To the down-trodden, a hero! To the evil, a ruthless enemy!

Finally, we meet and greet the mouse himself…Danger Mouse (the Euro). The Euro is the biggest currency counterpart with the dollar (making up 57% of the US Dollar Index). After a torrid April and May, the Euro has now rebounded to eight-month highs versus the US dollar, as signs of economic growth in the sixteen-nation currency bloc have eased concerns of sovereign defaults. The euro / dollar relationship is ever more relevant when it comes to crude oil, as the two have increasingly moved in a mirrored fashion in the past three months; as the euro rallies, so does crude.

What’s this? Will the Baron have the last laugh? Are our heroes doomed? Can they get to the bottom of this mystery before they reach the bottom? If not, will this show end early?

So where does this leave us? The Euro / US Dollar relationship is currently a big driver for crude prices, while strength in the Australian Dollar is indicative of emerging market demand for raw materials. As for the Yen, it indicates the world economy is still yet not on stable ground, when investors are willing to increasingly invest their funds in a country which has not paid over 1% interest on short-term interest rates in fifteen years. Anyway, enough horror stories from me, at least until next week…

2 Comments on this post:

  1. Juan V. says:

    Matt,

    is it possible that the strength in the Yen is the unwinding of the mother of all carry trades? or maybe the Japanese, who are likely net savers, sent their money abroad to improve their returns and began to call in their chips because of retirement (or stopping themselves out because the trend started going against them)

  2. Matt Smith says:

    Hey Juan, I really don’t buy into the strength in the Yen being the unwinding of the mother of all carry trades (eloquently put though, because it really was); I believe the great unwind occurred back in 2008 if not before, when the Yen strengthened from 120 into double digit terrain.

    I also can’t see it being because of the repatriation of funds either – why the rush now? I believe its more related to diversification, and the fact that the yields in the rest of the world have retreated to the realms of JGBs (Japanese Government Gonds), making them suddenly comparatively attractive.

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