Currency Wars?

If the G7 release yesterday seemed that they completely ignored any indication whatsoever of currency manipulation by individual countries to drive their currencies in to the ground as fast as possible and ahead of anyone else, than I think you took away the real, intended meaning of the statement, but just like the Troika, the IMF, the G20 and others, the G7 severely underestimated the common sense of every day people and more so the market.

The reason the G7 doesn't want to come out with a strong statement condemning the currency wars?
Well of the 7, 3 are part of the Euro-Currency block, France, Germany and Italy-France has been VERY vocal about their feelings on the current valuation of the Euro, "It' way too high", I'm not sure where Italy is, Germany seems to think it's not good, but it's better than a lower Euro as it will keep Germany more competitive than France.

Of the other 4 members, 3 are actively engaged or spoken out in defense of devaluing their currencies and Japan's right to do it. Japan is probably the worst offender or at least has the weakest currency, yesterday the US Secretary of the Treasury endorsed Japan's Yen destruction, today the Bank of England's outgoing head, King, also endorsed the currency devaluation in Japan and elsewhere.

Why destroy your currency? For some, I think there's a hint of this in Germany, optically a strong currency mens a strong "looking" nation or union, I also think Germany is afraid that a sinking Euro will re-ignite the sovereign debt yield crisis, sending sovereign yields back to unsustainable 6-7+% levels in the PIIGS. 

Back to the question, it's multi-fold depending on the nation and their situation, if Greece had not been tied to the Euro it is likely they could have deflated their way out of trouble, but they don't control the exchange rate of the Euro.

As you'll see in Japan's case, a country that has seen more than a lost decade, nearly a lost generation, their efforts really stepped up as they entered a fight with China over a couple of small, uninhabited islands that each claim for themselves, all Japanese goods were shunned in China and Japanese exports fell to unsustainable levels, thus to make their exports more competitive, they devalue their currency so other countries can afford to buy more.

In the US for instance, we have the "Full Faith and Credit of the U.S." and yes you will be paid back for bonds your grandparents bought 30 years ago, it's just by the time they are paid in full, the F_E_D will have destroyed the US dollar so badly that your grandparents will have actually lost money in loaning money to the U.S. and with China and other sovereigns no longer the biggest holder of US debt or even interested in buying it, the F_E_D needs to pick it up, how? Control + P=Print which means more money in circulation, which means the value of the dollar is lower and guess who is punished? The savers, those who were responsible as their savings are worth less every month, it's the spenders who benefit... hmm.

What does this mean to the Stock Market? For one, the value of the US Dollar means a lot to stock and commodity prices, a stronger dollar means weaker risk asset prices, a weaker dollar means stronger risk asset prices, but more importantly right now, there's the carry trade.

The Carry Trade...

The basics of the Carry Trade is when an investor sells a certain currency with a relatively low interest rate and uses the funds to purchase a different currency yielding a higher interest rate, this is often accomplished with FX pairs like the EUR/JPY or the AUD has been a popular one, the  Yen is almost always involved.

If a trader borrows $10,000 Yen at 0% interest and buys US Dollars and a bond at 3.5% yield and then uses 10:1 leverage, they stand to make 35% so long as the rates between the two countries don't change or the currencies don't change too much because if the Yen rises in value and the Dollar shrinks, the carry starts losing money. 

Often instead of a bond, the investor buys high yielding stocks, like momentum stocks which is why this chart from yesterday is so important...

In red we have the S&P-500, in green the percentage of stocks that are 2 standard deviations above their 40-day price moving average, in other words these are the high flyers hedge funds want to buy with carry trade money because they return the most. The problem is as the SPX has been rallying, these stocks have went from 44% of all NYSE stocks listed to 13%, it looks like the carry trade is being close as they take profits on the assets and use the money to sell $USD and buy back the Yen or whichever pair they used. Since there's a risk of a single currency pair moving against traders, they typically buy a basket of multiple carry currencies.

Here's why I keep placing more and more importance on the currencies...These were captured about an hour ago...

 This is the most common pair, the EUR/USD, whichever currency is first, here the Euro, the chart denotes the Euro's movement vs the USD, if the chart moves up, the Euro is worth more and the USD worth less, if the chart moves down, the USD is worth more and the Euro less. This morning the Euro took a bit of a plunge, sending the USD up which is not helpful for stocks as a stronger dollar pressures risk assets that are traded in US Dollars.

It looks like the ceiling for the ECB/Draghi is $1.35, they don't seem to want the Euro moving above that level.

 A little longer term the EUR/USD has been trending up, this is supportive of the stock market and the stock market often moves in tandem with the Euro or the EUR/USD and moves opposite the USD. However, lately the Euro has been making lower highs and lower lows vs the USD, this is not good for stocks and looks like the start of a change in trend that WILL effect the stock market.

 This is "Cable" or one of the oldest pairs, the Great British Pound vs the USD, this morning around the 10 mark (not EDT) is when the Bank of England's King made his remarks supporting the devaluation race, the GBP fell vs the USD as you can see quite sharply on his comments. In other words, the UK is not going to see itself put at a competitive disadvantage in exports because every other country is manipulating their currency lower; the British are getting in on the game as well.

 One of the Carry pairs, the EUR/JPY (Euro/Yen) has seen a dramatic increase since about December, look at the stock market during this period, however on the daily chart above we have recent congestion...

 Here's the same pair on a 5 min chart, note the sideways movement and loss of uptrend, this costs carry traders money and that threatens the trade, which threatens the stock market as well as other risk assets.

 And the pair this morning, not good for stocks.

 Another carry combo, the USD/Yen, as long as the USD is moving up here, the Yen is moving down and the carry is working, this is a daily chart.


 On the same pair's 5 min chart, note the recent sideways movement, around the same time the market started sideways and very volatile.

The pair got a boost on King's comments at 10, but started down later with the rest of the pairs.

When you add 100x leverage or even 10x leverage as they often/always do, small movements against their positions can lead to huge losses, this can shit the trade in a day and send the market plummeting. We are on the edge right now.