Assiduous Readers will remember that on September 5 I noted a paper regarding foreign exchange rate prediction – there is another paper on VoxEU today titled Where are commodity prices headed next? Look at exchange rates by Chen, Rogoff & Rossi:
Figure 2 shows the rate of growth of the IMF global commodity price index (the US dollar price index of over 40 exchange-traded primary commodities, weighted according to world export earnings) since 1994. It has indeed been highly positive in the past 5 years, resulting in the high price levels shown in Figure 1. Our forecast based on the exchange rates, labelled “Model Forecast”, is strikingly close to the actual realisation. Indeed, we find that such forecasts of future commodity prices are significantly better than forecasts that rely on traditional statistical models, such as an auto-regression or a random walk.
…
This forecasting success of commodity currencies is no deus ex machina but has a sound and intuitive economic basis. It follows naturally from the fact that exchange rates are asset prices that embody expectations of future movements in macroeconomic fundamentals, specifically ones that will directly affect the exchange rates. For commodity currencies, global commodity prices matter to their exchange rate values.
I am hesitant to criticize anything by Rogoff (for whom I have great respect) in the field of FX (his speciality) … but as stated in this very brief article, the mechanism sounds a little circular. ‘We can’t predict FX rates, but we can use them to predict commodity prices, because they’re moved by predictions of commodity prices which predict FX rates’.
The best stab I can make – as a complete non-specialist, understand, and looking at no actual numbers whatsoever – is that FX rates might be driven by foreign takeovers of producers by other producers (a mechanism often seen in Canada over the past few years) who might have a better handle on balance of risks (impending shortages and lengthy order books) than might the general public. But this mechanism is not investigated in the paper.
Top credit market story of the day was, of course, the fallout from the Fannie/Freddie takeover. Mortgage Backed Securities gapped in big-time which generated a lot of duration buying, which caused Treasuries to rally.
Fixed-Reset issues celebrated their ascension to respectability (by which I mean, of course, incorporation into the HIMIPref™ database) by losing money. PerpetualDiscounts had a good day.
| Note that these indices are experimental; the absolute and relative daily values are expected to change in the final version. In this version, index values are based at 1,000.0 on 2006-6-30. The Fixed-Reset index was added effective 2008-9-5 at that day’s closing value of 1,119.4 for the Fixed-Floater index. |
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| Index | Mean Current Yield (at bid) | Mean YTW | Mean Average Trading Value | Mean Mod Dur (YTW) | Issues | Day’s Perf. | Index Value |
| Ratchet | N/A | N/A | N/A | N/A | 0 | N/A | N/A |
| Fixed-Floater | 4.57% | 4.57% | 64,659 | 16.06 | 6 | +0.0139% | 1,119.6 |
| Floater | 4.36% | 4.42% | 51,462 | 16.48 | 2 | +0.0000% | 902.4 |
| Op. Retract | 4.94% | 4.26% | 127,057 | 3.32 | 14 | -0.0841% | 1,053.6 |
| Split-Share | 5.32% | 5.78% | 50,534 | 4.33 | 14 | +0.2933% | 1,048.2 |
| Interest Bearing | 6.38% | 7.05% | 53,453 | 5.21 | 2 | -0.5162% | 1,106.5 |
| Perpetual-Premium | 6.15% | 5.41% | 60,382 | 2.22 | 1 | +0.3953% | 1,008.9 |
| Perpetual-Discount | 6.02% | 6.09% | 187,474 | 13.75 | 70 | +0.1113% | 884.4 |
| Fixed-Reset | 5.05% | 4.89% | 865.717 | 13.59 | 6 | -0.1650% | 1,117.6 |
| Major Price Changes | |||
| Issue | Index | Change | Notes |
| IAG.PR.A | PerpetualDiscount | -1.5633% | Now with a pre-tax bid-YTW of 6.32% based on a bid of 18.26 and a limitMaturity. |
| POW.PR.D | PerpetualDiscount | -1.2458% | Now with a pre-tax bid-YTW of 6.18% based on a bid of 20.61 and a limitMaturity. |
| SLF.PR.A | PerpetualDiscount | +1.1364% | Now with a pre-tax bid-YTW of 6.08% based on a bid of 19.58 and a limitMaturity. |
| PWF.PR.L | PerpetualDiscount | +1.2623% | Now with a pre-tax bid-YTW of 5.96% based on a bid of 21.66 and a limitMaturity. |
| CM.PR.E | PerpetualDiscount | +1.2903% | Now with a pre-tax bid-YTW of 6.46% based on a bid of 21.98 and a limitMaturity. |
| CM.PR.P | PerpetualDiscount | +1.3195% | Now with a pre-tax bid-YTW of 6.50% based on a bid of 21.50 and a limitMaturity. |
| SLF.PR.C | PerpetualDiscount | +2.7778% | Now with a pre-tax bid-YTW of 5.91% based on a bid of 18.87 and a limitMaturity. |
| Volume Highlights | |||
| Issue | Index | Volume | Notes |
| L.PR.A | Scraps (would be OpRet, but there are credit concerns) | 112,275 | CIBC bought 10,000 from RBC at 22.35, then another 25,000 from Scotia at the same price. Now with a pre-tax bid-YTW of 8.31% based on a bid of 22.35 and a softMaturity 2015-7-30 at 25.00. Assiduous Reader adrian2 gets his wish and the Loblaws issue – very poorly received when issued in June – makes it on the board (again!) despite its less-than-stellar credit. I’d say that, as above, after two-plus months of trying, the underwriters have found a level where this thing will sell … and that they’re under the gun to get it off the shelf well before bank year end in October. |
| TD.PR.S | Fixed-Reset | 33,305 | |
| BAM.PR.O | OpRet | 25,650 | Now with a pre-tax bid-YTW of 7.41% based on a bid of 22.90 and optionCertainty 2013-6-30 at 25.00. Compare with BAM.PR.H (6.27% to 2012-3-30), BAM.PR.I (5.48% TO 2013-12-30) and BAM.PR.J (6.44% to 2018-3-30) … well … looks to me like they finally found their level and this is the inventory blow-out special! |
| BMO.PR.M | Fixed-Reset | 24,220 | Nesbitt bought 13,000 from anonymous at 24.94. |
| BNS.PR.Q | Fixed-Reset | 23,576 | |
| TD.PR.Y | Fixed-Reset | 20,924 | |
There were sixteen other index-included $25-pv-equivalent issues trading over 10,000 shares today.
I looked at the Rogoff submission out of curiosity. It is clear that currencies of Canada, Australia and other commodity producers are strong CORRELATED with commodity prices over the most recent 5-year period, but it is less clear in general whether one leads the other or whether the changes are more or less simultaneous. That they are correlated is not surprising given the importance of commodity exports to these countries. Correlation alone does not provide forecasting ability.
The authors claim (without providing the details of their specific evidence) that currency changes LEAD commodity price changes. However, when I look at their figure 2 it looks to me like quite a bit of the time commodity price changes LEAD currency changes (i.e. the change in commodities comes BEFORE the change in FX rates). To get a useful signal, the lead has to be consistent. If FX led commodities 55% of the time in the past (perhaps enough to “validate” their model), how do we know it will be different from 50/50 in the future?
[This reminds me of the ice core data on global warming — there is an amazing correlation between CO2 and temperature BUT sometimes one leads the other and sometimes it is the reverse. As a trained scientist, I and many others in a quiet minority are not sure which is leading which in the current CO2/Temperature scenario. Al Gore got into trouble with British Courts who declared his movie An Inconvenient Truth to be political propaganda for, among other reasons, claiming that temperature led CO2 generation unequivocally.
The parallel with commodity prices / FX is perhaps important because in the global warming debate, IF CO2 leads temperature, the LAG TIME is quite important. Is it months, years, decades, centuries or millenia (there are decent arguments for the longer periods)? If more than a few years, then CO2 already released has not had its full effect on temperature yet so even immediate precipitous action would not prevent further short to medium term temperature rise already “baked in” at current CO2 levels. Likewise, if FX leads commodity prices, is it by minutes, days, weeks, months or quarters?]
For FX/commodities we have to ask the same questions and test leads and lags with a great deal of care before we can be conclusive about the historical forecasting ability of FX rates.