Friday, October 2, 2009
Eur/Usd technical perspective
Starting the day
Hi everybody, and welcome back! I have a terrible cold these days, part because of a sudden return of winter to Buenos Aires, part maybe because I’m a bit over excited on coming to the ITC! Really for me will be a hell of an experience also, travelling alone, away from my girls. They are still too young, I had travelled in the past, not since I become a mom. Life changes a lot! Anyway, forex! forex! not me! As we talk last night in the Daily Wrap Up Webinar, here at FXstreet.com at 22:30 GMT, gold remains the forex market leader. Where gold goes, there goes dollar. Back above $1000/oz, rising almost 10 dollars in the last 24 hours, and dragging greenback down across the board. Data around the world since past Asian session has been quite positive, except maybe for Europe inflation readings, supporting greenback falling trend. But don’t you there to talk about deflation in the euro zone ok? Anyway, we have GDP and ADP in the U.S. in a couple of hours, so market will wait also for that, to see where are we heading from here. Here is the link for today’s calendar:
Majors’s sentiment for today
Here is majors sentiment for today:
Eur/Usd: Bearish
Gbp/Usd: Bearish
Usd/Chf: Bullish
Usd/Jpy: Bearish
Eur/Gbp: Bullish
Starting the day
Hi everybody and welcome! Monday again, and some risk aversion is seen since early Asian opening, with stocks down, losing some key level we are going to see in a few minutes, and gold contained under $ 1000/oz. Majors seem to have find a top against greenback, and movements are developing with different strength across the board. Mostly consolidating this morning, Yen strength, that reached the 88.20 zone early Asia, also points for more risk related movements. The currency has rose strongly against major rivals, reaching multi months lows, and rebounded quite strongly from there. Still not bottom seem at this point. Anyway, here is the link for today’s calendar:
EUR/USD weekly charts
Monday, September 7, 2009
Weekly Trading Update - August 31 - September 04 2009
Well thankfully it's been a much more profitable week this week after two winning trades on the EUR/GBP and GBP/USD pairs. There was also an opportunity to trade the EUR/USD pair as well this week but despite the daily Supertrend indicating a bullish trend, I'm reluctant to go long at the moment because I think this pair's heading lower in the next week or so. Plus there's been a lot of sideways action on this pair recently which is enough to put me off.
Anyway back to my trading results for this week and the first trade was on the GBP/USD pair on Tuesday afternoon. I had been waiting for this pair to break downwards and it do so convincingly during one 4-hour period. So as a result of the EMAs crossing downwards I entered on a pull-back at exactly 1.6250.
Thankfully the price continued downwards and I closed half the position for 50 points and let the other half run, moving my stop loss down to break-even. Later on the price had moved down to around 1.6125 so as it was getting late I moved my stop loss to 1.6150 and my target price to 1.6050 and let it run overnight. Sadly the stop loss was the one that got triggered but it was still a decent enough profit.
Incidentally the GBP/USD pair looks as if it may be about to cross downwards before the day is out, but I'm hoping it will hold on until next week because these crossovers often have much more momentum behind them at the start of the trading week.
The other trade was on the EUR/GBP pair and if you've been reading my blog this week you will know all about this trade already because I discussed it in some detail in this blog post. As I mentioned at the time this was a low-risk high-reward trade, and thankfully the 30 point stop loss wasn't triggered and I managed to bank a healthy profit of 74 points.
It has actually dropped another 40 points since then but I was so bored watching this pair that I closed out the position shortly after it hit my initial price target.
Nevertheless it's been a profitable enough week on the whole.
(If you would like to find out more about my main 4 hour trading strategy, you can access it for free when you subscribe to my newsletter. Simply fill in the short form above).
Why Do So Many Forex Traders End Up Losing Money?
A lot of people have jumped on the forex trading bandwagon in recent years. They've heard about how much money you can potentially make by trading the currency markets and have leapt head-first into this exciting industry.
However once they open an account and start trading, they soon realise how difficult it is. Indeed the vast majority of people will end up losing money. So where do they go wrong?
Well firstly they will often start trading without using a proven trading system, ie a system that has generated profits consistently on a long-term basis. The systems that they do use are often sub-standard ones they have bought on the internet or read about on the various forex forums.
They may even choose to use a forex robot if they don't fancy trading the markets themselves. However again while there are some profitable expert advisors, many of them will end up losing money in the long run.
The other major problem is most people new to forex trading do not have a firm grasp of money management, and more specifically how to manage risk. As a result they will often overexpose themselves when they enter a position which will eventually lead to them being completely wiped out in a lot of cases.
Well anyway if you yourself have trouble understanding risk management, then you may like to know that Bill Poulos has just released a new training video which covers this particular subject.
In this video he reveals the #1 reason why so many traders lose money and remedies this by providing you with the perfect risk/reward ratio that you can use as part of your trading plan. He also shows you how you can eliminate risk from every single trade you make.
You can watch this video by clicking here.
The EUR/GBP Pair - An Excellent Shorting Opportunity Above 0.88?
I've been watching the EUR/GBP pair very closely this week. Since dropping below 0.85 last month it's been steadily climbing upwards and in recent days it's been hovering just above the 0.88 level. However there are signs starting to emerge that this pair could be about to turn downwards.
If you look at the 4 hour chart for this pair and draw the Supertrend indicator you can see that although it's green, it has flattened out a lot, which is always a good indication that the bullish trend is running out of momentum.
Furthermore you can also see that the price has so far posted three recent highs of 0.8839, 0.8835 and 0.8833. Therefore it's clear that this pair is clearly struggling to breakout and post new highs.
This is why I personally believe that there is an excellent low-risk high-reward trading opportunity available on the EUR/GBP pair at the moment.
Indeed I opened a short position earlier this morning at 0.8820 and believe it could work out very nicely. I have placed my stop loss roughly 10 points above the highest high at 0.8850 in case the price does eventually break upwards, but I intend closing the position at somewhere between 0.87 and 0.8750 (I haven't decided yet).
The way I see it is that I'm perfectly prepared to risk a small 30 point loss in order to potentially make 70-120 points.
Let's see how it turns out.
(UPDATE: You could die of boredom watching this pair but thankfully I've finally managed to close this position at 0.8746 after it finally dipped below 0.8750. So this was a decent enough profit in the end).
Weekly Trading Update - 24-28 August 2009
Well it's been another frustrating week with a lot of sideways trading action but the summer months are coming to an end now so hopefully things will pick up in the next few months. There were just two trades this week using my main 4 hour trading strategy. They were both winners but I don't think I'll be ordering the yacht just yet.
The trades in question were on the GBP/USD and USD/JPY pairs. Both of these were in bearish trends on the daily chart (according to the Supertrend indicator) so I was only looking for shorting opportunities on the 4 hour charts.
The first trade occurred on Monday afternoon when the EMAs crossed decisively downwards on the GBP/USD pair. I went short at 1.6432 and ended up holding on to it overnight. My initial target price of 50 points was achieved the following morning and after closing out half the position I let the other half run, moving my stop loss down to break-even.
I had to go out on Tuesday afternoon so I set my target price at 1.6230 because I really believed a 200 point profit was easily achievable on this latest downwards move. However I was incredibly frustrated to come back and find that it had taken out my stop loss at break-even. Worst still the price did then go on to fall to this level (and indeed all the way to 1.6154). So it's fair to say that I was not amused.
The USD/JPY trade occurred on Tuesday morning after the EMAs crossed downwards. I went short at 94.27 but wasn't particularly confident about this one. Because I was going out I set both my stop loss and my target price at 40 points. Thankfully it did reach this target in the end but I was very close to being stopped out on two separate occasions.
So overall a steady but unspectacular week. By the way just like last week there has been an upwards EMA crossover on the EUR/USD pair but the decisive crossover candle was again too long for my liking.
If you would like to receive full details of my main 4 hour trading strategy, you can access it for free when you subscribe to my newsletter. Simply fill in the short form above.
Fibonacci Analysis and Forex Trading: A Match Made In Heaven
I've got something a little different for you today because the article below is a guest article from John Robinson (forextraders.com). It's a detailed article about fibonacci analysis and how you can incorporate it into your forex trading. I don't discuss this subject very often on this blog so hopefully you will find it useful.
Who knew that a mathematical theory developed sometime in the 13th century would have so many applications today? Leonardo Fibonacci, the Italian mathematician for whom the Fibonacci theory is named lived between 1175 and 1250, but his theory lives on today. In fact, Fibonacci is one of the most often used technical analysis tools by traders of all asset classes, but its applications when it comes to forex analysis are especially useful.
Understanding the Fibonacci theory is easy. It states that each term in a sequence of numbers is the sum of the previous two numbers. (1,1, 2, 3, 5, 8 and so on.) The sequence isn't all that important to understanding Fibonacci for forex analysis, but the power of the so-called Golden Ratio is. The Golden Ratio is basically the quotient of the adjacent terms and that number is 1.618 or 0.618 as an inverse. How important is this number? Just type Fibonacci 1.618 into a search engine and watch how many results turn up that involve the practical application of this number.
But enough with that. How can Fibonacci be used to make a forex trading strategy more profitable? Used in forex analysis, Fibonacci's golden ratio is translated to three numbers 38.2%, 50%, and 61.8%. Five lines are drawn on a chart including these three numbers with 100% and zero percent. Obviously, 100% is the high and zero percent is the low.
The interesting thing about the Fibonacci levels on a forex chart is that they frequently act as places where prices start to rebound or as support and resistance levels. On a traditional five-line Fibonacci chart, a currency pair that has retreated from the 100% line is likely to find support at the 61.8% line. If the pair doesn't find support there, that is a signal for to sell it short. Knowing this, it's fair to say the Fibonacci theory is a useful tool for trend traders.
On the other hand, Fibonacci can also be a profitable tool for short term trading. If scalping is part of your forex trading strategy, then you should not be without Fibonacci charts on your trading platform. As we said above, Fibonacci levels often represent price areas where a forex pair starts to rebound, so using the example above of currency that has peeled back from the 100% Fibonacci line, it is likely to find support at the 61.8% line and start to move higher again. If you take a look at a long-term chart, say an hourly or daily, and draw Fibonacci lines, you're bound to see several examples of the Fibonacci lines acting as areas where a previous price trend started to reverse.
The point is that short-term traders are often getting thrown around by market movements because they don't properly identify the most important price levels in a given forex pair. Proper use of Fibonacci lines can help prevent this problem and put the odds in favor of the forex trader. And no, you won't need to draw the lines yourself by hand. Most charting packages come with a Fibonacci feature.
Smart forex traders know that trading against the trend is perilous to the health of their account and that their forex analysis regimen needs to include trend identification. Fibonacci is a superior tool for keeping a forex trading strategy on the right side of the trend.
Forex Volume is Down – What are the Implications?
According to a recent report by the Reserve Bank of Australia (RBA), forex volume is down in nearly every major category. “However, turnover declined by over 20 per cent between October 2008 and April 2009 to US$2.5 trillion, to be at its lowest level in over two years, a move reflected in all six markets indicating global, rather than location-specific, causes. The largest markets – the United Kingdom and the United States – experienced the sharpest percentage falls.”
The report was based on a survey of the world’s six largest forex trading hubs – US, UK, Japan, Canada, Singapore, and Australia – and produced a few interesting revelations. The first is that forex volume peaked well after other capital markets. This can probably be attributed to the notion that there is never a bear market in forex. In other words, after stocks and bonds began to collapse in the summer of 2008, investors embarked on a mission, unprecedented in its speed, to move capital from risky countries to safe-haven countries. This switch, by definition, required the forex markets to facilitate.
This point is further illustrated by the fact that, “the decline in turnover of spot and forwards occurred somewhat later than that in foreign exchange swaps and derivatives….Spot turnover reported in October 2008 was likely to have been supported by large cross-border capital flows as investors sought to reduce risk by repatriating foreign investments. In addition, the high frequency and impact of news at the height of the crisis would have generated the need for investors to frequently adjust their positions.”
The final revelation is that the change in forex volume was not always commensurate with changes in trade volume. A general relationship between trade and forex turnover has been observed, although speculators ensure that currency is exchanged much more frequently than actual goods and services. The two currency pairs registering the greatest unbalance are the CHF/USD and CAD/USD. Forex volume for the former fell much more sharply than trade, while the opposite is true of the latter. One can only speculate as to why this is the case. As for the CHF/USD, forex volume probably suffered disproportionately more because both the Swiss Franc and US Dollar were perceived as safe haven currencies, in which case it would be relatively less useful to exchange them for each other. In the case of the CAD/USD, meanwhile, it makes sense to view the imbalance in terms of the spectacular decline in trade, which was largely a product of declining commodity prices.
It’s impossible to predict whether forex volume will remain depressed. Given the efforts underway to increase regulation and curtail leverage, I don’t personally expect volume to recover for a while. As for the implications, the less might be to stick to the majors. If volume is declining, it will probably affect emerging market currencies most. Lower liquidity might translate into higher volatility. However, it’s worth pointing out that volatility has been declining ever since it skyrocketed after the collapse of Lehman Brothers last fall. In that case, it might be that investors are behaving more prudently with less funds to trade with.
Forex Markets Indifferent to Bernanke Nomination
Earlier this week, President Obama officially nominated Ben Bernanke to a second four-year term as Chairman of the Federal Reserve Bank’s Board of Governors. The reaction was relatively muted, perhaps because most pundits had already anticipated the news. Bernanke himself probably sealed his own re-appointment with the public relations campaign he embarked on last month, ostensibly to offer a rationale for his response to the credit crisis. “In a profound departure from the central bank’s tradition as an aloof and secretive temple of economic policy, Mr. Bernanke has plunged into the public spotlight to an extent that none of his predecessors would have contemplated.”
Most of the sound-byte reactions came from politicians, and focused on whether he deserved another term, rather than the potential ramifications of his re-nomination. Heavyweights Barney Frank and Christopher Dodd both offered tepid support. Ron Paul referred to the news as irrelevant. Meanwhile, “European Central Bank President Jean-Claude Trichet on Tuesday said he was ‘extremely pleased’ by President Barack Obama’s decision.”
The reactions from investors, likewise, ranged from ambivalent to moderately supportive. Equity markets rose to a 2009 high the day after the story broke, while the Dollar fell slightly. The re-appointment was deliberately awarded five months ahead of schedule in order to help the president’s credibility with investors. Fortunately (or unfortunately, depending on how you look it), the fact that the markets didn’t react much, shows that they don’t really care. In other words, “President Obama overstated matters when he said that Mr. Bernanke had kept us out of a Great Depression” not only because “this remains to be seen,” but also because the ebbs and flows of GDP are contingent on more than just monetary policy.
Regardless of how much credit Bernanke actually deserves, he will certainly have his work cut out for him in his second term. “Bernanke’s Next Tasks Will Be Undoing His First,” encapsulated one headline. At some point, the Fed must raise interest rates, return credit markets to normal functioning, and remove hundreds of billion of dollars from the money supply.
But this is easier said than done: “If the Fed shifts too quickly from the role of savior to that of strict disciplinarian, it risks aborting the recovery and tipping the nation back into a recession, essentially repeating mistakes made in 1937 after the economy had begun to rebound. If the Fed moves too slowly, it risks the kind of intractable inflation it experienced in the 1970s and fueling another bubble.”
The consensus is that, for better or worse, he will err on the side of price stability, perhaps at the expense of economic growth. “A Fed chaired by Ben Bernanke will follow a policy uncomfortably tight as the 2012 election looms into sight. Bernanke has espoused a commitment to low inflation over his entire career,” argued one economist. Meanwhile, the markets aren’t expecting rate hikes at least until 2010, although Bernanke, himself, has conveyed a sense of optimism – and hence hawkishness – about a quick exit from recession.
What does all of this mean for the Dollar? It’s impossible to say exactly, and depends largely on whether Bernanke can unwind the easy money policy of the last year just as deftly as he deployed it.And of course, there is the wild card of the US National debt, and the potential for a loss of confidence to induce a run on the Dollar, which even Bernanke would be powerless to solve.
Carry Trade Still Popular, but Doubt is Growing
It’s safe to say that the inverse correlation observed between the Dollar (and also the Yen) and global equities is largely a product of the carry trade. “The U.S. stock market bottomed and the U.S. Dollar Index peaked almost simultaneously in March. While U.S. stocks are up more than 50% in that time, the Dollar Index (which measures the greenback’s value against the euro, the yen, the British pound, the Canadian dollar, the Swedish kroner and the Swiss franc) is down nearly 12%,” observed one analyst.
On one level, this represents a return to 2008, prior to the explosion of the credit crisis, when carry trading was THE dominant theme in forex markets. However, there is one important difference. While the Dollar and Yen were the funding currencies then and now (due to their low interest rates), there has been a slight shift in the currencies selected for the opposing/long end of the trade.
Traditionally, the most popular long currencies were those of industrialized countries, rich in commodities and backed by high interest rates and often rich in commodities. To be sure, these currencies have shined in recent months, certainly due in part to speculative (carry) trading. “Strategists at Wells Fargo Bank in New York ‘believe that the gains in the dollar-bloc currencies (Australia, New Zealand, Canada) have run ahead of the gains in commodity prices.’ ” The Bank of Canada also noticed that “At the time of its last statement, oil prices were about $75 a barrel, but now they are in the $60-to-$65 range. That suggests the currency’s appreciation has outpaced the demand for its commodity exports.”
But the run-ups in the Kiwi, Aussie, and Loonie have been overshadowed by even more rapid appreciation in emerging market currencies. This shift is largely a product of changes in interest rate differentials, which are now gapingly large between developed countries and developing countries. Compare the 2.75%+ spread between the US and Australia, with the 8.5% spread between the US and Brazil or 12.75% between the US and Russia. For investors once again becoming complacent about risk, the choice is a no-brainer.
Still, some analysts are nervous about this change in dynamic: “While the new carry trade may be less leveraged, it’s an inherently riskier bet. As such, it’s more vulnerable to the kind of swift unraveling of risk appetite observed across all nations and sectors in 2008, but which occurs with far more frequency in emerging markets.” Meanwhile, emerging market stocks have behaved volatilely over the last few weeks (with Chinese stocks even entering bear market territory), and some investors are concerned that they may be temporarily peaking. There are also signs that bubbles may be forming in carry trade currencies, with bullish sentiment at high levels. Accordingly, one strategist suggests waiting out a 5% pullback in the Australian dollar, and a 10% pullback in the New Zealand dollar before going back in.
There is also the outside possibility that the Fed will raise interest rates, which would crimp the viability of the US Dollar as a funding currency. Granted, it seems unlikely that the Fed will tighten within the next six months, but investors with a longer time horizon could begin to adjust their positions now, rather than wait until the 11th hour, at which point everyone will be rushing for the exits.
Australian Dollar Rises, Remains Closely Correlated with Stocks
The performance of the Australian Dollar over the last six months has been nothing short of incredible: “Since the end of February, the Australian dollar has risen 29% against the U.S. currency,” and a still-impressive 18% if you backtrack to January, when the Aussie was still in free-fall.
As has been the trend in forex markets of late, the currency’s rise cannot be attributed to an improvement in fundamentals. The economic picture remains nuanced (that is putting a positive spin on it), and definitive proof of recovery has yet to emerge. “We really are trawling pretty deep to try and get any snippet of information that might have some backhanded relevance as far as Australia goes,” said one analyst.
As a result, fundamental analysts have been forced to wait for a “more precise picture about the timing [of] any Reserve Bank of Australia interest rate hike.” On this front, investors are ratcheting down their expectations of a rate hike anytime soon, as “The RBA has signaled that there’s a danger of raising rates too soon.” Futures prices reflect the expectation that rates will rise by only 37 basis points from current levels before 2010, and by 161 basis points 12 months from now.
With such economic uncertainty, investors have turned their attention elsewhere. “Nomura Chief economist Stephen Roberts said in the absence of any clues about the fundamental drivers of the currency, nearly all the cues in foreign exchange markets are being taken from equities.” Some analysts have posited a close relationship with the US stock market: “The correlation between the Aussie dollar and U.S. equity market in particular has been very strong over the past few weeks, with our analysis showing a correlation as high as 95 percent.”
For other analysts, the relationship is with the Chinese stock market. This correlation makes more sense logically, since the Australian economic recovery is largely contingent on continued growth in China and the concomitant purchases of Australian commodities. “Currency markets will be watching the Shanghai share market, which has been a pretty big influence on the Aussie recently,” summarized one analyst. A reporter for the WSJ tried to spell it out even more clearly in an article entitled, “Australian Dollar Up Late, Closely Tied To Chinese Stocks.”
Unfortunately, the correlation with (Chinese) stocks runs both ways. When the Chinese stock market tanks – often for inexplicable reasons – as it has for the last three weeks, the Australian Dollar follows suit. Another analyst is more blunt: “The story for the Australian dollar and other risk- and growth-oriented currencies is similar to the share markets. They’ve had a great run and are probably due a bit of a pullback.”
Dollar Reverts Back to Former Self
Only two weeks ago, analysts were singing about a new day for the Dollar, which had risen on the basis of good news for the first time in months. In hindsight, it looks like such talk was premature, as the Dollar has returned to its old ways. Good news once again causes the Greenback to fall, while bad news causes it to rise.
This development (or lack thereof) suggests that investors may have gotten ahead of themselves, when they sent the Dollar surging after the employment picture brightened slightly. At the time, the news was interpreted as a sign that rate hikes were imminent. On a broader level, it was a sign that investors had dumped the paradigm of risk aversion, in favor of a model based on comparing economic fundamentals. Since then, investors have slowly moved to distance themselves from the notion that the Fed will soon hike rates, and in the process have moved back towards trading based on risk dynamics.
As a result, positive news developments over the last couple weeks have coincided both with a rise in equity prices and a decline in the Dollar. When the Chinese stock market collapsed one day last week, investors responded by dumping high-yield assets, and moving temporarily back into “safe haven” currencies. “Diving Shanghai Helps Dollar” read one headline. “Worries over the continued fragility of the world economy outweighed a firmer tone in overseas equity markets to underpin the U.S. dollar versus major counterparts,” explained another report.
Meanwhile, a divide is forming among fundamental analysts. There is one school of thought which argues that the US will be the first industrialized economy to recover, and hence the first to raise rates. Based on this line of reasoning, then, positive economic news provides a foundation upon which to buy the Dollar. A competing school of thought, meanwhile, has suggested that regardless of if/when a US recovery materializes, it will be overshadowed by out-of-control inflation. In this regard, then, the Dollar is not such an attractive buy.
No less than the venerable Warren Buff has insisted that the Fed’s quantitative easing program and the US economic stimulus plan – while necessary – threaten to create even bigger problems than the ones they purport to solve. “But enormous dosages of monetary medicine continue to be administered and, before long, we will need to deal with their side effects. For now, most of those effects are invisible and could indeed remain latent for a long time. Still, their threat may be as ominous as that posed by the financial crisis itself,” he said.
If this true, then the Dollar is damned either way. Damned in the short-term as a result of a pickup in risk appetite, and damned in the long-term due to inflation.
Record Rise in British Pound comes to an End
From trough to peak (March 10 – August 5), the British Pound appreciated by a whopping 25%, its strongest performance in such a short time period since 1985. The Pound has fallen mightily since then, and most factors point to a continued decline.
On almost every front, the Pound is being buried under a mound of bad news. Its economy is currently one of the weakest in the world, especially compared to other industrialized countries; on a quarterly basis, its economy is contracting at the fastest rate in over 60 years. Forecasts for UK economic growth are commensurately dismal: “Median estimates in Bloomberg economist surveys see the U.S. shrinking 2.6 percent in 2009 and expanding 2.2 percent in 2010, compared with a 4.1 percent contraction followed by 0.9 percent growth in the U.K.”
In addition, the only signs of growth appear to be a direct result of government spending, a notion that is evidenced by the latest retail sales and housing market data, both of which remain at depressed levels. “People are worried that the global recovery is based on unsustainable government spending and numbers like this from the U.K. only encourage those fears,” said one analyst in response.
While government spending, meanwhile, is arguably a valuable tool for stimulating economic growth, analysts worry that it might be reaching the limits of feasibility. “The Office for National Statistics said the budget shortfall was 8 billion pounds ($13.2 billion), the largest for July since records began in 1993.” On an annual basis, the government is planning to issue 220 Billion Pounds in new debt, to fund a budget deficit currently projected at 12.4% of GDP, easily the largest since World War II.
The Bank of England’s prescription for the country’s economic woes are also provoking a backlash. When the Bank announced at its last monetary policy meeting that it would expand its quantitative easing program by 50 Billion Pounds, the markets were aghast. Imagine investor shock, when the minutes from that meeting were released last week, revealing that 3 dissenting governors were agitating for an even bigger outlay! No less than Mervyn King, the head of the bank, “push[ed] to expand the central bank’s bond-purchase program to 200 billion pounds ($329 billion).
Given the dovishness that this implies, combined with an inflation rate that is rapidly approaching 0%, investors have rightfully concluded that the Bank is nowhere near ready to raise interest rates. “The market was expecting the BOE to be one of the first to hike rates. It’s becoming clear that’s unlikely, undermining the pound,” conceded one economist. Interest rate futures reflect an expectation that the Bank will hold rates at least until next spring. LIBOR rates, meanwhile, just touched a record low.
As a result, forecasts and bets on the Pound’s decline now seem to be the rule. “BNP Paribas…predicted another 9.3 percent decline to $1.50 in 12 months…After the Bank of England decision, pound futures and options speculators became more pessimistic as weekly bets favoring sterling fell more than 32 percent, the most since November.” In short, “Sterling is over-priced at current levels.”
All Eyes on Central Banks
While Central Banks have always featured heavily in the minds of forex traders, their actions have taken on a whole new significance of late. Financial reporters have also been generous in doling out space to stories about Central Banks, writing stories with headlines like “Central bankers add to equities’ momentum” and “Currency Traders Hold Fire, Await Central Banks.”
Traditionally, forex traders eyed Central Banks for one reason: interest rates. The theory was simple: currencies with higher interest rates tended to outperform in the short term. This trend was especially reliable in the years leading up to the housing bubble, as carry traders ensured that high-yielding currencies rose while low-yielding currencies stagnated or fell.
Even in the context of the credit crisis, traders have continued to monitor the rate setting activities of Central Banks. Interest rates in every industrialized country are currently locked at record low levels, but anticipation is already starting to build that the beginning of a tightening cycle is just around the corner. Current expectations are for the US to lead the way (first to lower, first to rise), followed by Australia, New Zealand, and Canada. The Bank of England and European Central Bank are further away on the curve, while rate hikes are a remote possibility in Japan, a perennial favorite of carry traders.
Interest rates are now only a small part of the equation, however. Most Central Banks have implemented additional strategies, known variously as quantitative easing, asset purchases, liquidity programs, etc. The goal of all of these programs is to stimulate the money supply and stabilize financial markets, by injecting newly-minted money directly into capital markets. Traders initially focused on which Central Banks were involved in quantitative easing. After nearly every bank introduced some version, it quickly became a question of scope. In this respect, the Fed and the Bank of England are in first and second place, respectively. Now, traders are waiting to see not only when these programs will end, but also when they will be unwound. If there is a perception (and even worse, a reality) that some Central Banks are waiting too long to draw funds out of the market, this could foster (concerns of) inflation, and consequently, currency depreciation.
Finally, there is the issue of direct currency intervention. The Swiss National Bank became the first western bank to intervene on behalf of its currency. Its actions are directly responsible for holding the Swiss Franc down. The Bank of England meanwhile has used its quantitative easing program to influence the Pound, while the Banks of Korea and Brazil are buying Dollars on the spot market to depress their respective currencies. Paranoia is clearly running high, and some traders are apparently concerned that the Fed could be next. Just when you thought the surprises were over.
euro retreats from 2009 Highs
In forex, timing is everything. If I had written this post a couple weeks ago, the headline would read “Euro Touches 2009 High.” Perhaps if I had waited another week, it would have read, “Euro Approaching 2009 High.” But alas, I chose today to write about the Euro, and the headline I chose is probably the most appropriate under the circumstances.
On August 5, “The euro hit a high for the year against the dollar as stocks trimmed their losses in afternoon trading Wednesday despite a generally cautious tone in currency markets.” Analysts were careful to point out that the markets remained cautious and the Euro eased past – rather than smashed through – its previous high. Technical analysts would and have argued that this paved the way for the subsequently rapid decline: “The euro is testing the base of an ascending channel with daily momentum charts showing a ‘double top in overbought territory.’ ”
This notion might have some merit, considering that fundamentals arguably favor a continued Euro appreciation. “The economy of the 27-country European Union shrank 0.3 percent in the three months ended June 30, for an annual rate of roughly 1.2 percent. The 16 countries that use the euro registered a 0.1 percent decline for the second quarter, or an annual rate of roughly 0.4 percent.” While output remains well below its 2008 levels, the slight contraction represents a tremendous improvement from the first quarter, when GDP shrank by 2.5%.
“Underlying the strong reading were solid performances in France and Germany, each of which grew 0.3 percent in the second quarter, government data showed.” This is helping to offset further contractions in Italy and Spain, which have turned into economic laggards as a result of the housing bust. In addition, exports in Germany grew by 7% last month, and “Investor sentiment improved more than analysts had expected in August to its best level since April 2006.” On an aggregate basis, “the euro zone’s trade balance with the rest of the world rose to 4.6 billion euros ($6.5 billion) in June, compared to a flat balance in the same month last year,”
Still, explorers looking for bad news and/or cracks beneath the surface will have no difficulty finding them. German exports (and output in general remain down year-over-year. In addition, there are still trouble spots in the EU, notably in western Europe. “Already, the euro area’s unemployment rate stands at 9.4 percent, its highest level in 10 years, and the anemic growth of the coming quarters will not be enough to arrest the slide. That, in turn, could drag down consumer confidence or even generate political backlash in Europe, economists said.” Most worrying is perhaps that, “consumer prices in the euro area dropped 0.6 percent in July…” ‘Deflation is becoming entrenched in the euro area, which would be very bad for the economy.’ ” Good thing the ECB left some room to lower rates further.
The Force is With the Yen
Just when it looked like the carry trade was back for good and all signs pointed to a Yen depreciation, out of nowhere came a series of surprise developments, propping the Yen back up. Spanning finance, economics, and politics – a Forex Trifecta – these developments moved swiftly through the markets, creating optimism for the Yen where before there was only pessimism. Of course, it’s possible that this bump will prove temporary, and a reversal could transpire just as quickly.
The biggest news, by a large margin, was a report that the Japanese economy had returned to growth. Similar in scale and in tenor to stories coming out of other countries, the data showed that Japan grew at an annualized rate of 3.6% in the second quarter of 2009, a sharp reversal from the 11.7% contraction in the previous quarter (which was itself revised upward from -14%).
The sudden sea change was brought about by a combination of government spending and export growth. “New tax breaks and incentives to help sales of energy-efficient cars and household appliances, coupled with lower gas prices and a rebound in share prices, spurred consumer spending. Prime Minister Taro Aso has pledged 25 trillion yen (about $263 billion) in stimulus money, including a cash handout plan and more public spending on programs like quake-proofing the country’s public schools, to revive the economy.” Meanwhile exports grew by a healthy 6.3% from the previous quarter, while imports fell, causing the trade surplus to widen.
The announcement of economic recovery was accompanied by a noteworthy reversal in capital flows, such that Japan’s capital account swung into surprise weekly surplus: “Foreign investors bought 292.9 billion yen ($3.1 billion) more Japanese stocks than they sold during the week ended Aug. 8 and domestic investors were net buyers of 125 billion yen in overseas bonds and notes.” Meanwhile, speculation is mounting that Japanese investors will move to repatriate some of the coupon and redemption payments they receive on their US Treasury investments.
While seemingly unrelated to the economic turnaround (it’s important not to read too much into weekly data), this could be a sign that Japanese investors are growing more optimistic about domestic economic prospects and are moving to invest more at home. It’s worth noting that such a shift could actually be necessary if the recovery is to be sustained, in order to increase the role of (capital) investment, relative to exports and government spending. Ironically, it could instead be a sign of excessive pessimism, if Japanese believe that prospects for US/global growth have been overestimated, in which case risk appetite and the carry trade would be due for a combined correction.
Domestic consumption could also play an increasing role in Japan’s economy going forward, as a result of imminent political changes. “To stimulate consumption at home, the Democrats have pledged to put more money in the hands of consumers by providing child allowances, eliminating highway tolls and making fuel cheaper. That marks a shift away from the long-ruling LDP’s emphasis on steps to help companies.”
Along similar lines, the Democratic Party (which has a wide lead over the incumbent Liberal Democratic Party), has also conveyed its opposition to currency intervention, since such tactics inherently prioritize export growth over domestic consumption. “Japan’s export-led growth is reaching its limits and Tokyo should not intervene in markets to weaken the yen as long as currency moves match fundamentals, the No.2 executive in the main opposition party said on Monday.” Could the carry trade be in trouble?
Brazil Real Edging Up, Despite Efforts of Central Bank
The Brazilian Real has been one of the world’s best performers in 2009, having risen by a solid 25%. The currency is now close to pre-credit crisis levels, and is even closing in on an 11-year high. When you consider that only six months ago, most analysts were painting doomsday scenarios and predicting currency devaluations and bond defaults for the entire continent, this is pretty incredible!
The currency’s rise has been supported by a variety of factors, few of which are grounded in fundamentals. To begin with, while Brazil has staved off depression, it’s not as if the economy is firmly back on solid footing. The economy contracted by 5% in the first quarter, and forecasts for 2009 GDP growth still vary widely, from a slight contraction to modest expansion. Meanwhile, the economy is importing more than it exports, despite the rebound in commodity prices. “The central bank said the net trade result was based on $9.89 billion in receipts for exports and $12.72 billion in import payments overseas.”
“Investment inflows, meanwhile, totaled $33.88 billion, while outflows totaled $29.78 billion.” The disparity between investment and trade data goes a long way towards explaining the Real’s rise. Thanks to a recovery in risk appetite, foreigners have poured cash into Brazil at an even faster rate than they once removed it. As a result, Brazil’s “Bovespa stock index has risen 51 percent this year, the world’s 12th-best performer among 89 measures tracked by Bloomberg, as foreign investors moved 13.7 billion reais into the market through July, the most since the exchange began tracking data in 1993. Brazilian local bonds returned 37 percent in dollar terms after falling 13.8 percent in 2008.” The country’s foreign exchange reserves also just set a new record, surging past the $200 Billion mark.
Brazilian interest rates tell the rest of the story. Despite a gradual decline over the last decade (made possible by a moderation in inflation), Brazil’s benchmark SELIC rate stands at a healthy 8.65%, which is the highest in South America, after Argentina. Unlike Argentina – and the dozen or so other economies around the world that boast equally lofty interest rates – Brazil is perceived as relatively safe place to invest. Given interest rate levels in the western world, combined with the expectation that Brazil’s currency will appreciate further, investors are more than happy to accept a little bit of risk in order to earn an out-sized return.
Just like the Bank of Korea, Bank of England (both profiled by the Forex Blog in the last week), the Bank of Brazil is not happy with the resilience in its currency. “Brazil’s central bank said on Wednesday it bought $779 million on the spot foreign exchange market this month to Aug. 7 as dollar inflows to the country surged because of growing demand for local stocks and bonds.” This brings the total intervention expenditure to $9 Billion.
Unfortunately for the Bank of Brazil, the forces in the forex market are way beyond its control. “Dollar inflows to the country totaled $2.26 billion this month to Aug. 7, compared with inflows of $1.27 billion in all of July.” Analysts are also unconvinced, and are racing to revise their Real forecasts upward. One economist, caught completely off guard, just “changed his year-end real forecast to 1.8 from 2.5 at the start of the year. ‘The resilience of the Brazilian economy to weather this crisis has been spectacular,’ ” he explained.
