On FX and Worst Fears

Two market developments are worthy of note today (so far). Gold is up 2.5% (off a very cheap low) and USDYEN and EURYEN have made very significant 1.3% moves down.

Stuff like this scares me. It looks like acceleration in the flight to quality. The news backdrop is terrible and supports a panicky market outcome. My ability to look into the future has gone to zero.

For those that follow this blog for my read on FX, I cut out my short on the Euro and the long on USDYEN today. The outcome was (sort of) what I anticipated. I collected a few dimes on net. This was always a trading position, having lost my rudder on what might happen next, I'm just taking oars out of the water.

It's been my experience that my “Worst Fears” on matters of global macro economic developments never come true. Some of my worst fears at the moment:

- A full-blown bank run in Europe. This is already happening. It is happening in cash by the billions at the bank teller windows and cash machines, it is happening by the hundreds of billion in electronic transfers. It can't go on much longer.

There is a story/rumor going around that Euro denominated bills will soon be stamped with a single letter of country origin. This is what may happen in Greece. To stop the cash drain from the local banks, bills taken from a bank/ATM would have a red G on them. Any money transfers out of the country would similarly be flagged G (or temporarily blocked). Functionally a two tiered Euro will have been created.

If (when) this happens the bank run will explode in Spain, Portugal and Ireland. The precedent will have been set with Greece. The response by authorities will be more stamped money, this time with red S's, P's and I's. Basically the whole ball of wax melts down.

In that scenario, what would the value of a EURUSD marked with a G or an F be? My answer is that it would be far higher than the 1.2700 it is at the moment.

My point is that it is not entirely clear what it means to be short the Euro against another currency, currently. I want to be short the Euro that will be marked with the dreaded S, P, or I (or maybe one with red IT?), but I don't want to be short the one with a G.

Exchange controls of some form or another are not far away.  If there is a two tiered Euro being formed by events in Greece, then contracts, including FX contracts, will be settled with the Euros that are the strongest legs of the two tiered system. While there are long odds for this outcome, they are odds I do not want to play.


- If things keep up as they are in the financial markets, there will be another problem someplace that is not now on the radar. It could be in Eastern Europe, or even Russia. My bet is it comes from Asia, possibly China. There will be liquidity issues someplace.

This story by Izabella Kaminska talks about the potential for a problem (link).


- There are other things on my radar that could be trouble. One that could be a kick in the pants is a “failed” IPO for Facebook.

Nevertheless, I think this deal will be a huge success. It will be a monster IPO that raises record amounts of capital. More shares will be sold to the public than has been assumed. There is a big ‘Green Shoe” of additional shares that the underwriters have to offer if there is post issue market demand.

I expect that the stock will open at a big premium to the IPO price, and then rise some more. What I'm afraid of is the print at 3:30.

There is an aspect to this deal that is a bit troubling. Mark Zuckerberg has made it clear to the underwriters that he wants a good portion of the stock sold in the IPO to go retail investors who believe in Facebook. Those investors would not stand a chance of getting any stock in a normal IPO. Good for Marky.

But that is not how IPOs work. Deals get “hot” because retail investors want to own shares, and those investors typically have been excluded from getting shares at the IPO price. Retail is normally the force that gets an IPO a 10%+ pop at the opening.

But what if a fair chunk of the retail demand that is needed for the stock to catch a bid has already been filled?

This is a very big deal with some unusual features. It will be priced rich with lots of shares sold. If there is a pop tomorrow morning that results in the green shoe getting filled, and the flippers (like me) get out, it could lead to a disappointing day.

Who knows? We might have a $100b lead weight on our hands.

Note: The results for FB may get tainted by news from Europe or elsewhere. What's the chance for bad news from Europe tomorrow? A Friday? High, is the answer.
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