am/FX: Electric Shock

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• Macro > positioning
• UK electricity
• EM trade balances
• Near Earth objects are low odds but high EV if they hit

by Brent Donnelly

August 24, 2022

https://www.hq.nasa.gov/office/pao/FOIA/NEO_Analysis_Doc.pdf

Your odds of dying from a direct asteroid hit are greater

than your odds of dying by lightning or earthquake.

Because of the math (asteroid hit = many or everyone dead)

Current Views

Short ES1 @ 4272

Stop loss 4366

Take profit 4010

August 23, 2022

Electric Shock

Europe is experiencing a massive exogenous macro shock. Yet people are still asking me about positioning in EURUSD. i.e., “Is everyone short??” Macro is bigger than positioning. Everyone was long USDJPY 80 to 120 in 2012-2015. Everyone was long EURUSD 1.05 to 1.40 in 2003-2006.

The piece I sent yesterday got some positive feedback as I think it’s easy to underappreciate the epic moves in the EU trade balance. They are especially notable as they seem more structural than cyclical. Barring peace in Ukraine, or a radical policy volley from the EU, it’s hard to imagine things getting substantially better the way cyclical things tend to do.

Major structural shifts in trade balances tend to have a meaningful impact on the currency and that impact tends to go beyond a few months. We have seen this with the JPY a few times, with KRW in 2016/2017, and many other examples. On the other hand, the positive terms of trade shock to Australia hasn’t had much impact due to various transmission issues, so it’s not guaranteed that trade always drives the currency.

Power Move

Here’s the latest on UK power prices.

UK baseload power, forward winter price (GBP/MWh)

Since early 2021:

Since 2005:

The average of the series from 2005 to 2020 is 51. Trading above 700 today, from 600 yesterday. Therefore, today’s rise of 100 is about 2X the average price of power. In one day. There is nothing the Bank of England can do about this, and it will end up becoming a fiscal policy issue of some sort. Either price caps or rationing or something more radical.

While I understand the variety of issues in the UK, this move up in UK yields reminds me of the move higher in German yields from 3.7% to 4.7% that took place from March to June 2008. That move, a response to zippy commodity inflation in the midst of rapidly deteriorating economic conditions proved unsustainable. To say the least. I find it very hard to imagine that any amount of currency weakness or credit fear or fiscal concern can keep UK yields up here for more than a few months.

USDCNH Chart Update

USDCNH is often a good momentum and tech trade because the techs let you know when the authorities have loosened their grip. The pennant/triangle break August 16 (am/FX: A good time of year to buy FX Vol) has followed through and here’s how things look now:

USDCNH daily since the devaluation

The vast majority of price action since the 2015 deval has been in the 6.25/6.98 range. The second equilibrium zone was 7.00/7.20. My bet is that we stall as we get to 6.98 as stability will take priority with the Party Congress and Golden Week coming up soonish. Once those events are out of the way (Congress date not known, Golden week October 1 to 7) … A push to 7.20 into year end is possible. For now, I would be selling 1-month 7.00 strikes against any long USD exposure or selling 1-month to buy 3-month.

To be clear, this is my base case: Rally to 6.98 over the next two weeks. Stall and trade for a month or so. Rally to 7.20 in November/December.

Trade Imbalances Part Deux

People asked me how the trade balance charts look in EM, and I did my best to present them in today’s am/FX. There is a lot of adjusting from monthly and yearly data and millions and billions, so I hope that I have not made any errors. As I am not an EM expert, it’s possible that there is data in here that does not pass the sniff test. If so, please let me know.

The first chart is all the countries where I could find good data. Obviously, China and India dwarf everything else, but I show this complete list for context and so you can see the relative size of the immense Chinese surplus and Indian deficit.