Hopes for QE3 rose after the terrible NFP, but with extremely low yields, the Fed is running out of bullets. Spain just doesn’t have enough money to go around, and is much closer to a bailout that European leaders admit, says David Rodriguez of DailyFX.
In the interview below, Rodriguez discusses Spain, QE3, Japan’s debt, global deleveraging and more.
David Rodriguez is a quantitative analyst for DailyFX.com, specializing in statistical studies in currency trading markets and algorithmic trading systems for the Managed Accounts Programs offered by parent company, FXCM. He holds a degree in Economics from Williams College with heavy emphasis on quantitative methods and began trading financial markets in the tech boom and bust of 1999-2001. Since then, David’s primary focus has shifted from equities to currency markets, but he continues to trade futures and futures options on a broad range of asset classes as well as currencies.
1. As Spanish banks and regions struggle, the national coffers are under pressure and yields are peaking. How real is a scenario of a Spanish bailout in the near future?
Way more real than European officials would like you to believe. I think Spain has largely reached the point of no return as the recent Bankia troubles and fiscal troubles in the regional government of Catalonia underline funding difficulties. The Spanish government not-so-subtly depends on domestic banks to purchase Spanish government bonds. The banks in turn depend on the central government to bail them out if they become insolvent.
Then you have the case of Catalonia-the strongly nationalist Autonomous Community of Spain. Given clear funding difficulties, they turned to the central government for liquidity. The problem is clear; there’s not enough money to go around. This isn’t a problem that is going to go away by itself, and the likelihood of a bailout grows by the day.
2. Operation Twist is nearing its end. Is this a chance to introduce new policy measures by the Fed?
Last week’s strongly disappointing US Nonfarm Payrolls report leaves all eyes on the Fed’s next steps. Yet with interest rates at record lows across the board, you have to ask yourself-what could they realistically do? They already own approximately 10% of the US Treasury’s debt and yields continue falling to fresh lows. Can they bump holdings to 20% and bring them down further? Unlikely. I think the Fed is running out of options to produce monetary stimulus in light of the massive deleveraging across the US economy.
3. Britain enjoys lower yields due to the euro crisis, yet its economy has some dependency on the continent. How will the pound react to a major event such as a Greek exit or a Spanish bailout?
We’ve seen the British Pound rally sharply against the Euro given Euro Zone crises, but the rate of appreciation has slowed markedly as of late. I still think the GBP stands to appreciate versus the Euro in the event of a Greek exit or similar. Yet it’s clearly strong links to the Euro area mean that it is likely to fall noticeably against greater safe-havens such as the US Dollar and Swiss Franc.
4. Japan recently received a credit rating downgrade and its debt mountain is inconceivable in Western terms. Do you think that the fact that debt is held locally means many more quiet years or is it a time bomb that will affect the yen sooner?
It really is remarkable to see the massive debt to GDP ratio (currently near 220%) in Japan and yet its exceedingly low government bond yields. I think the biggest reason that Japan is able to keep yields so low is simple: global interest rates are at a cyclical low. Given the fact that investors are actually accepting NEGATIVE yields on 3 and 6-month German government bonds, positive rates in Japan don’t seem that bad. I expect Japan, the US, and other countries to remain solvent as long as interest rates do not jump dramatically.
5. The Australian dollar has been hit by worrying signs from China, the euro crisis and some domestic weakness. Which factor is the most dominant in your opinion?
Deleveraging. It’s simple: the Australian Dollar has been a major beneficiary of speculative capital chasing high domestic yields and strong growth. As yields fall and growth slows, there is an inevitable exit of these speculative trades and in turn a large deleveraging in the global Australian Dollar long position. These are not distinct factors; they all play into the same end of financial deleveraging.
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