Assets Volatility and the US dollar - the end of the post Lehman era?

"The illiterate of the future will not be the person who cannot read. It will be the person who does not know how to learn." - Alvin Toffler 

While we recently touched on the dollar's appeal whenever there was a pullback in our conversation "Time for a pullback? Get some greenbacks!", many pundits are commenting on the radical change in the trend of the US dollar in recent weeks. It seems the US dollar is reacting as a "Risk-On" asset on the back of the recent raft of positive economic data coming from the United States, as well as benefiting from the "Quantitative race" led by the Bank of England and the Bank of Japan as well as the difficult economic situation in Europe. A few strategists are concluding that it marks the end of the the post-Lehman period and a return to a more normal macro environment.

The evolution of the Dollar Index (blue line), Volatility 1 year ATM (At the Money) for the S and P500 and the Eurostoxx 50 (red lines) since 2009 - source Bloomberg:

"The Dollar Index, which Intercontinental Exchange Inc. uses to track the greenback against the currencies of six U.S. trade partners, has climbed about 3.9 percent this year on signs of a broadening economic recovery, after declining 0.5 percent in 2012. Based on Bloomberg Correlation-Weighted Indexes, the dollar climbed 3.3 percent this year, making it the second-best performer after Sweden’s krona among 10 developed-market currencies. The Dollar Index rose for a fifth straight week through March 8, its longest rally since June, as American employers added more jobs last month than economists forecast, adding to signs the U.S. recovery is outpacing other developed nations." - source Bloomberg - Dollar Rally on U.S. Growth Endorsed by Jen as BNP Sees Reversal

In at a recent note from Bank of America Merrill Lynch entitled "Sweet spots and sellers's strikes", from the 14th of March, one can notice in the below graph displaying their GFSI, (being their global risk index integrating volatilities, credit, money markets, etc) falling towards 2007 lows while the DXY (Dollar index) is breaking away:

"Higher US Dollar & Lower Volatility = End of “New Normal” But without a doubt the biggest worry to investor positioning right now would be a reversal in the strong US housing and consumer story. Happily the latest US retail sales data allay such fears, and the leadership of the US in The Great Rotation remains ongoing. This is best seen by the decisive end to the post-Bear Stearns, deflationary relationship of strong dollar and higher volatility (Chart 3)" - source BAML

"It was just six years ago that the share price of Lehman Brothers reached an all time high. And less than five years after the investment bank declared the largest bankruptcy in US history, US stock indices are at new all-time highs. Thanks in great part to Ben Bernanke and other central bankers, Wall Street is once again riding high.

The big question is, can stocks hold or extend these highs? Our asset allocation is skewed toward a view that yes, equities can extend their gains over the course of 2013. But we also continue to think the probability and durability of that outcome would be improved by a “healthy pullback”." - source BAML

As far the DXY is concerned, it looks like since the beginning of the year, the Greenback has definitely staged a comeback!

"You can use all the quantitative data you can get, but you still have to distrust it and use your own intelligence and judgment." - Alvin Toffler

Stay tuned!

A run up to the second leg down...and no this time it is not different.

Back in December I highlighted that the theme for 2010 will be sovereign risk and I was also indicating the headwinds facing Greece in particular and the PIIGS in general. Yet the rally runs unabated in the equity market and credit spreads are tightening still, although major structural issues have barely been addressed.

In a previous post as well I encouraged readers of this blog to track the CRB index as I was expecting commodities to surge higher as the "recovery" (which should be rebranded inflation) is gathering pace.



Gold is trading at record level again and oil is also trading much higher. The surge of Oil will have some consequences on the GDP growth. It will start to be a drag before becoming a threat.

At the same time VIX has dropped significantly.



At these levels, VIX is getting my attention and a long dated ATM call option is looking more and more attractive as I expect a volatility spike in the very near future, this summer most likely.

And by the way 42 banks have failed in the US this year so far according to the latest count on the FDIC list of failed banks:

http://www.fdic.gov/bank/individual/failed/banklist.html

What are the structural issues that needs to be fixed and what are the current threats:

-"Too big to fail" is not acceptable for banks.
Hedge funds can fail and it happens (this what capitalism is all about) and apart from LTCM it hasn't been disruptive to the markets. Banks are not hedge funds and should not be allowed to act like ones using deposit money.

Glass-Steagall act should either be re-enacted or a reduction in leverage should be enforced. The taxpayers and goverments cannot afford bailing out the financial system anymore and in many parts of the world, it is seriously crippled. In Ireland for instance, the situation for Anglo Irish Bank isn't great to say the least and they need additional injection of capital directly from the government to shore up their core capital and tier one ratio which has been seriously impaired by the hits they have taken on their loans. The level of their NPL (Non Performing Loans = really bad property loans...)is staggering: 11 billions of Euros, of which 4.2 Billions of Euros have already been provided. AIB’s equity core tier 1 at the end of 2009 was 5 per cent, excluding the 3.5 billion euros of preference share investment done by the Irish government previously!

Ireland’s “bad bank” — the National Asset Management Agency (NAMA) is initially removing 16 billion euros of bad loans from three of the five Irish participating banks to purge their balance sheet.
An estimated 80 billions Euros of bad loans will eventually be transferred by September
The Irish taxpayers will be picking up the tab for the next 7 to 10 years it will take to clean up the mess...

-OTC products in general and CDS in particular: they should be cleared on exchanges -period. It would reduce counterparty risk as well as adding liquidity and transparency.

-Senator's Chris Dodd proposed bills at the US Congress for the FED are purely and simply dangerous and seriously threatening the already impaired independance of the FED.

http://www.bloomberg.com/apps/news?pid=20601087&sid=ar1GEW82NxDU

-Greece, the tip of the Iceberg.
1999 rating of Greece before joining the Euro: BBB+
9th of April 2010: Greece rating according to Fitch is now BBB-
The end of the game is approaching fast, similar to Lehman's situtation prior to its demise, Greece is experiencing massive capital flight from its banks, 10 billions euros have already been pulled out of Greek banks. Unsecured consumer borrowings for Greek banks has increased from 10% in 2003 to more than 20% today as a percentage of household disposable income (this figure is 23% in the US). Although Greek banks, have better tier one ratios than their Irish counterparts, the capital flight they are experiencing is fast and furious and doesn't bode well for their funding needs. Always remember that the banking industry is a leveraged play intensively correlated to the economy it is operating in and given the GDP contraction Greece has experienced and the state of the public finances, their fate is linked. Before Fitch's downgrade on Greece, National Bank, EFG Eurobank and Alpha Bank's ratings where BBB neg according to Fitch. You can expect Greek banks to be downgraded as well.
It is truly a Greek tragedy.



-United Kingdom upcoming elections: Conservatives need a clear majority, markets would react negatively to a hung parliament which could slow down much needed spending cuts and hurt even more the GBP. Soros is now talking about devaluation being an option for the UK government recently at a conference organised in Cambridge. It could be effective in reducing the debt burden, boosting exports in the short term but inflationary in the long term which would mean rates hikes down the line.