Maraging Partners

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FX Forecast for Q4 2015: EUR/USD, USD/RUB, EUR/RUB

Bos primigenius II

The prehistorical and extinct bovine specie , bos primigenius, who used to inhabit Europe, personifies the fourth quarter.

The FRS remained true to its pigeon in hawk's feathers image in Q3. The cartel's dilemma is well known: raise the rates and you invite

  • the slowing of economic growth in the periphery of the global dollarized economic system which is exactly where new capital and new consumer demand is being formed -- which includes the demand for the goods and services of the "old" economies
  • the strengthening of the USD, which will hit American export - dependent TNCs where it hurts
  • the further depression in the commodity prices, hitting Australia and Canada, in addition to the abovementioned periphery
  • higher borrowing costs making the US government and its programs costlier to maintain, which means higher taxes

Refuse to raise the rates and you have asked for

  • bigger asset bubbles in more places, including the US stock, bond and real estate market
  • erosion of confidence in the USD or rather in the ability of its eminent to play by the rules
  • higher borrowing volumes making the US governments and its programs costlier to maintain, which means higher taxes
  • eventual bursting of the bubbles with the deflationary effects as above, only in the form of an instant shock, with further drift of the economy towards nationalization and away from private property, via state - orchestrated bailouts and increased taxation.

Chinese operations in the dollar-renminbi market brought about some refreshing novelty in the "old normal" Chinese way of stimulating their American consumer and debtor. Usually the Chinese kept the renminbi cheap with respect to the USD and reinvested part of the export profit into the US Treasury paper, creating extra demand and propping up the value of these paper assets, which amounts to lowering the US interest rates. However, in Q3, the devaluation of the renminbi was accompanied by sales of the Treasuries. This looks like a mirror reflection of Fed's own Operation Twist of 2011, where Fed was doing something diametrically opposite, selling short durations and buying long ones. It's understandable that by shortening the portfolio's duration, the Chinese prepare for the rate hike, which is the opposite of the "economic stimulus" in the usual meaning of the term, with the caveat that we do not know what was done or will be done to the USD cash proceeds of both renminbi sales and bond sales. In the game theory logic of global speculation, this can be considered a preemptive action that possibly stole Fed's thunder regarding the hikes. We believe that while the Fed has lost a degree of control over the market by losing the ability to lower the interest rates, a growing share of decisions in the world of "high finance" will be made at the Chinese Politburo meetings. And given the broad range of instruments at the disposal of the Politburo, this implies that a larger fraction of influencing signals will be sent to the global economy via real - economy and Realpolitik channels.

In the last issue we said that the project of americano-centric globalization was becoming exhausted. With Russia stepping forward as the provider of protection services in the Middle East, the trend of de-monopolizing the global protection market, with the service becoming cheaper and more efficient, will, in our opinion, continue and grow. The tightening of the USD supply may well become part of the cheapening trend, since part of the bill for state-run protection is traditionally levied by inflationary dilution of the worth of money and fixed-income assets.

If successful, Russia's actions in the Middle East may lead -- in Russia's objective interests -- to the creation of a Shia buffer (Syria --Iraq --Iran) between Russia's internal Sunni zone and the Sunni monarchies of the Persian Gulf. In that case, the low hanging fruit for the IS will no longer be the Al Assad regime, but Saudi Arabia, which by the way produces a lot more oil. Have no doubt that the first news of the military action taking place amid Saudi oil fields will cause a lively reaction in the oil futures market and the correlated market of usd/rub. This is the kind of situation when an unlikely event of significant consequences makes a non - negligible contribution to the fair price of oil futures, and we believe the markets will begin discounting this scenario in Q4.

As far as Europe is concerned, we believe that the refugee crisis is caused by one time events in the Middle East and will not be a significant source of bad news in Q4.

Effective February 2013, our correlation analysis of the Russian future market, called FORTS, has been expanded into a separate analytical product, Market Correlations, to which we refer the interested reader. The review is issued monthly, and since Q4 2013, in English.

In USD/RUB and EUR/RUB, the futures premium (the spread between the futures and spot quotes) makes the profit/loss of the position include (but not be limited to) the profit (if selling USD/RUB or EUR/RUB futures) or loss (if buying the same) caused by the interest rate differential. As time goes on and the contract's expiry date approaches, the futures premium narrows and the buyer of the RUB realizes the futures premium. We always take these facts into account when developing the hedging strategies: given the present level of the interest rate differential, one has to have very strong reasons to buy USD/RUB or EUR/RUB futures for three months. On the contrary, carry trade strategies, those based on the interest rate harvesting, in a combination with intra-day systematic position adjustment, within the constraints of the given risk quota, form the basis of our Active Management service.

Interval boundaries corresponds to quartiles of the distribution, built according to the efficient market hypothesis. Probabilities in the table take into account the expert opinion formulated in the text. When the work on the forecast was over (October 5, 8 pm, Moscow time), the spot quotes were: EUR/USD: 1.118; USD/RUB: 64.85; EUR/RUB: 72.53.

A model position in each currency pair is proportional to the difference between probability sums of two right and two left fields of the table below. So, when the probability sum in the two right fields exceeds the sum in the two bottom ones, the futures contract is bought, in the opposite situation it is sold. The historical track record chart will be updated in the middle of the quarter.

EUR/USD below 1.08 from 1.08 to 1.18 from 1.18 to 1.15 above 1.15
probability, % 20 24 26 30
USD/RUB below 61.30 from 61.30 to 64.70 from 64.70 to 68.30 above 68.30
probability, % 26 25 25 24
EUR/RUB below 68.60 from 68.60 to 72.30 from 72.30 to 76.30 above 76.30
probability, % 24 25 25 26