Category — Currency

For several months, one of the hottest debates in the currency world has been “1.50 or 1.60?” Those who follow the Euro-US Dollar currency pair have been debating its future for several months. Since around the end of February, the price has been locked within a range of 1.50 and 1.60. Only on three days has the price ventured outside that area during the past few months, yet each of those days, the price closed back within the range. In other words, despite minor breaks, the tight range between 1.50 and 1.60 is still in play, signaling more uncertainty and likely more range-bound movements in the coming months.

Given that the EURUSD is the most liquid global financial instrument, the importance of the pair is unparalleled in the currency world (and it’s not even close). The EURUSD is involved in 27% of the trades in the FX market.¹ The next most commonly traded pair, the USDJPY, is involved less than half as frequently. Movements in the EURUSD ripple throughout the entire market, and looking back over several years, it is clear that many other currency pairs have mimicked the trends of this predominant instrument.

As there is presently a firmly established range, trading has become more tedious for many. Some traders thrive in range-bound markets, yet most do not. Many of the more well-known traders are not range-traders, but carry-traders. They thrive on trends and rollover, and while the rollover is still present in a range-bound market, the trends go out the window. The strategy of simply buying a currency and letting it sit for some time becomes more dangerous, as it is unclear which direction the price will move after breaking out of the range. While the trend for much of the decade in the EURUSD has been upwards, many analysts believe that the current range will eventually lead to an end of that overall trend. While I personally feel the opposite, the important point here is that range trade has certainly thrown a wrench into the trend. As a result of being in such a tight range, it has become much more difficult to predict future movements for the EURUSD.

The next few months promise intrigue for the pair. Now that each central bank, the US Federal Reserve and the European Central Bank, seem to be done moving rates for the time being, the pair should be allowed to fluctuate without fundamental interruptions. We will be able to see if the USD is ready to make a resurgence, or if this range is merely a bump in the road for the rise of the EUR.

Upcoming Figures
EUR Euro-Zone Trade Balance (May)
CAD Leading Indicators (Jun)

¹ I based my statistics off of the Bank for International Settlements’ “Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity in 2007”.

Last week I mentioned that though the G8 conference would impact the US dollar in the short term, the ultimate fate of the USD will ultimately be determined more by Bernanke than by anyone else. The Group of Eight’s meeting has come and gone, offering little good news for the USD. In the FOREX market, that “little good news” led to bad news for the USD, as the greenback surrendered some of the territory it had gained last week. So with the conference in the rear-view mirror… let’s look ahead.

In his most recent column, Robert Novak wrote that despite his publically hawkish stance, Bernanke is more concerned with growth rates. Furthermore, Bernanke feels that oil and gasoline prices, if they continue to rise, could lead to the dreaded state of halted growth in addition to rising inflation. Assuming that what Novak is reporting is accurate, it would seem that Bernanke’s pronouncements last week were a charade. In other words, Bernanke isn’t likely to walk the walk. However, this might not be a bad thing. Many see the economy as not yet ready for a rate hike, and so perhaps holding rates constant for the next several months would be the best thing for the US economy.

The USD has ended the rally it began last week, and while the short term prospects are dimmer than they were several days ago, the jury is still out regarding the long term. On the one hand, disappointing economic data that keeps coming out (most recently in the US: poor manufacturing results) would indicate that the USD is in for more stormy seas. However, analysts are noting that it has been years since people have held such bullish opinions about the USD. Many feel that the dollar is “due,” meaning that after taking its lumps for years, it is poised to finally recover. With the Saudis agreeing to pump more oil, perhaps the stars are aligning for a USD recovery. However, it’s hard to know the future for certain. As it is written in one of the Harry Potter books, we humans are not very good at reading the stars.

Upcoming Figures

AUD Reserve Bank of Australia’s Board Minutes (Jun)

EUR Italian Trade Balance (Euros) (Apr)

GBP Consumer Price Index (May)

EUR Euro-Zone Trade Balance (Euros) (Apr)

USD Current Account Balance (Q1)

USD Housing Starts (May)

JPY BoJ to Publish Minutes of Board Meetings

The surprising rally of the US Dollar this week has inevitably led to what seems like everyone and their niece predicting just how long it will last. My 10-year old niece doesn’t like the dollar, and though she’s a very bright girl, please note that she based her reasoning on the Canadian dollar looking a lot cooler than its American counterpart. Given that for several years the USD has done little but suffer, it’s of little surprise that few people are giving the greenback a chance.

Predicting the future can be a tricky business, so it’s important to follow some upcoming events that could determine the USD’s long term prospects. Some people throw caution to the winds regarding the future, such as Doc Brown, “Roads? Where were going, we don’t need roads.” In the world of Foreign Exchange, however, should you find yourself without a Flux Capacitor, it is very important to look at these events. They have guided currencies for as long as the market has existed.

In the short term, the upcoming G8 meeting could set the tone for the USD’s future. Should the USD become a focal point at the meetings (as it is expected to), one possible outcome would be a new dedication to strengthen the USD. There is a history of nations working to correct currency weaknesses, such as the Plaza Accord. However, while that agreement was aimed at the US facilitating the recover of the Japanese Yen, the tides have now turned.

Two more reasons for foreign countries to aid the USD are that commodities (such as oil!) are generally priced in dollars, and that the many countries holding dollar reserves would love to see those reserves have higher value. However, the results of the G8 will not be the only piece in shaping the USD’s future. The most important factor rests in the hands of Chairman Bernanke, and whether or not he can walk the walk as much as he has talked the talk regarding interest rate hikes.

Upcoming Figures

CHF Adjusted Real Retail Sales (Apr)

EUR Euro-Zone Consumer Price Index (May)

USD Net Long-term TIC Flows (Apr)

USD Total Net TIC Flows (Apr)

JPY Tertiary Industry Index (Apr)

Leverage allows any trader to control large amounts of capital; it is every trader’s best friend and worst enemy. We all realize that investing involves risk, and no one makes money without some degree of risk. That being said excess risk has another name: margin call. This isn’t the CME were your broker gives you a courteous call saying “pay up sucker,” no this is online currency trading. Or maybe you’re so confident in your trades that you never lose. Probably not if you’re like the rest of us then listen up, anything over 8:1 leverage is not smart. Some term it irrational exuberance, froth, or undue risk I call it stupidity. Moral of the story is, don’t swing for the fences. Chances are you’re a new trader and you have this wow I can control 1 contract with one thousand dollars feeling. Let me tell you there is only one George Soros, and you’re not him. Listen kimosabe go 100:1 and odds are tomorrow you will be margin called and have to explain to your self how you lost $1,000 in less than an hour. What’s worse you’ll stop trading leaving all the profits to the gnomes of Zurich.

Here are some rules to live by the first rule is 100:1 is a sucker bet don’t do it. The second when you start on margin know Wall Street almost never goes above 8:1. Be humble because the currency market is a 24 hour market so you’re competing with the legendary gnomes of Zurich, the PRC, and hedges funds on Wall Street. While something may seem obvious to you, there is probably a counter argument developed by someone with a lot more money to allocate and therefore leverage than you. We can’t forget what Keynes said regarding the market, “The market can stay irrational longer than you can stay solvent.” Do your self a favor stay solvent long enough to gain market experience because once you’ve become hooked it’s better than heroin and you have a good chance of making money too. The best way to stay solvent long enough to enjoy the market is let me hear you yell, “…..” you should know but if you’re the slow type it’s supposed to be, don’t over leverage.

Something monumental has happened: the US dollar has done well, and it didn’t require a divine intervention.

With most of the trading week gone, the USD has walked all over the Euro to the tune of over 2%. And perhaps the most interesting detail was that this rally did not start on the heels of some unexpected economic recovery; it started with Bernanke finally utilizing his clout. When he became Chairman, he stated that inflation would be his foremost concern. Two years later, after letting Wall Street bully him into a series of rate cuts, Big Ben has finally dug his heels into the sand.

Among other events, this week has witnessed dramatic rise in US unemployment, the ECB announcing that a rate hike is coming soon, and oil prices hovering around all-time highs. So, what does Bernanke do? He goes out and says that inflation is his top priority, the US economy will avoid recession, and the USD’s strength is also a focus for the Fed’s future actions. Are things actually turning around? Will the Fed really raise rates soon? I don’t think that anyone is certain… but that’s largely irrelevant. What is relevant is that Bernanke put on a brave face and exuded optimism, and the markets responded in a big way.

Elsewhere, the big players in the Euro zone are still trying to figure out what the best move is. First Trichet said that hikes are coming, and then several other ECB figures have clarified that announcement. Now the French Finance Minister has publicly pleaded with the ever-hawkish Trichet to rethink his coming actions. The uncertainty and lack of unity over the future (unlike the Fed, which has displayed a unified stance) has likely been a contributing factor to the USD sticking it to the EUR. As we move towards the close of the week, it will be interesting to see if Bernanke’s words (along with any forthcoming data – see below) are enough to fuel the USD’s surge.

Upcoming Events

EUR Italian Consumer Price Index (May)

EUR Italian Consumer Price Index – EU Harmonized (May)

USD Consumer Price Index (May)

USD Consumer Price Index Ex Food & Energy (May)

The US Dollar ended its rise against the Euro, as the ECB had several officials speak out in predicting future rate hikes. It is unclear if the ECB is planning a single increase (likely in July), or a series of hikes, as the officials volunteered differing opinions on the subject.

One continuing storyline is how markets worldwide are responding to central banks’ suddenly hawkish tones. Interest rate hikes have already occurred in countries such as India and Denmark, and larger players such as the ECB and the Fed are sounding like they may also raise rates in the near future. Some economists, such as Harvard’s Martin Feldstein, are worried about the possibility of minor stagflation arising from these policies.

In other news, the Swiss has rallied against the USD and the euro. Crude Oil futures are up almost 5%, and Bernanke cautioned that further price pressures could cause problems for the entire world.

Upcoming Events

USD Fed’s Beige Book

USD Advance Retail Sales (MAY)

NZD Retail Sales (APR)

JPY Bank of Japan Monthly Report

EUR German CPI (MAY)

EUR German CPI – EU Harmonised (MAY)

The People’s Bank of China may be in a position to use its $1.33 trillion currency reserves as a bargaining tool against U.S. lawmaker demands. Xia Bin, director of financial research at the State Council Development Center, believes China can use its holdings of U.S. government debt to its advantage. As the world’s second-largest holder of U.S. Treasuries of $407 billion, the selling of U.S. asset holdings would significantly lower their value. U.S. Treasuries fell yesterday after traders cited in a U.K. Daily Telegraph report that China may threaten to sell its holdings in U.S government debt if the U.S. imposed trade sanctions (see more in an article by Kathy Lien).

On July 26^th, the U.S. Senate Finance Committee approved legislation that would place higher duties on Chinese imports. These higher duties should compensate for the undervalued yuan. U.S. lawmakers since the beginning of the year have expressed concerns that an undervalued yuan is hurting U.S. companies. The People’s Bank of China has bought huge sums of U.S. government debt in order to keep its yuan artificially low.

With a high foreign currency reserve, a central bank is able to issue more than sufficient amounts of its domestic currency to stifle demand. If demand decreases when the economy bottoms out, the central bank would have plenty of foreign reserves to buy back the domestic currency. The enormous influx of capital from its incredible trade surplus is what has allowed China to maintain the world’s largest foreign currency reserve.

Despite numbers for April and May this year showing cuts in PCB U.S. Treasury holdings after 17-months of purchases, the central bank has indicated it would cut holdings anytime soon. President Bush and Henry Paulson agree it would be “foolhardy” for China to cut holdings in U.S. debt. Selling off these assets would strengthen the yuan significantly and thereby lower export value. Both have indicated that a mutual trade flow without penalties on imports should persist. Yet, with its true actions always a secret to the public, it remains to be seen what the PCB will decide if U.S. import duties do come into play. The PCB could use its huge foreign reserves to put a dent into the U.S. economy. The situation has turned from a question of economic policy into a potential political showdown.  

After modest gains this week, the U.S. dollar fell against the yen and euro on news of poor U.S. jobs growth. A government report today showed 92,000 jobs added for July, falling well below expectations as 126,000 jobs were added in June. Economists at Bloomberg predicted 127,000 new jobs for the past month. In addition, the unemployment rate rose unexpectedly to 4.6 percent up from 4.5. These are signs the U.S. economy is still hurting from the subprime crisis as investors are losing this week’s earlier appetite for risk. The dollar fell to $1.3727 against the euro this morning in New York, down from $1.3703 yesterday. The increase in risk aversion has also caused the dollar to fall against the yen from 119.21 yesterday to 118.93 this morning.

Poor U.S. job growth and resulting increase in unemployment may prompt the U.S. Federal Reserve to lower interest rates this year to reboot growth. This may be a sharp change in monetary policy as rates have been kept strictly at 5.25 percent for 2007. Mathew Strauss, a senior currency strategist at RBC Capital Markets Inc. in Toronto, comments: “The payroll number raised concern that the slowdown in housing may start to affect growth. It seems one supporting factor for U.S. consumers may start to lose ground—a strong labor market.” Investors betting on futures contracts on the fed fund rate due in December changed forecasts on the yield to 5.02 percent, down from 5.21 percent from a month ago. The Fed will next meet on August 7^th.

Currency Outlook and Forecast:
The decisive factor for the future U.S. dollar movement is the subprime crisis. The big question bothering investors is whether the U.S. housing slump will spill over into the rest of the U.S. economy. Speaking on this issue, Jim Rogers, co-founder along with George Soros of the Quantum Fund, believes losses from the subprime-market have a long way to go. According to Rogers: “This [subprime defaults] was one of the biggest bubbles we’ve ever had in credit.” He forecasts U.S. investment banks and homebuilders will take further hits. Bear Stearns stock fell 13 percent last week. Shares in other investment banks such as Merrill Lynch and Lehman Brothers also fell this week.

Kathy Lien, chief currency strategist at FXCM, forecasts August to be a tough month for the U.S. dollar. She believes tighter credit and the housing blowup will have significant negative effects on the U.S. economy this month (see her article at dailyfx.com). Don’t expect steady long term gains in the dollar anytime soon, especially as the Fed may be lowering the borrowing rate later this year.

Despite last week’s small gains against the euro, the U.S. dollar fell against the European currency on speculation of further weak U.S. growth. It may seem like old news, but investors fear further losses on securities backed by subprime mortgages to weaken the U.S. economy. Today, Germany’s IKB Deutsche Industriebank AG reported losses directly linked to the U.S. subprime mortgage crisis. Along with last week’s Deutsche Bank report, this indicates corporate debt to be at risk from the weak housing market. The dollar fell to 1.3678 against the euro this morning, a 0.3 percent drop from last week.

The risk of owning corporate debt has sky-rocketed, also a factor in the euro gain. Bond buyers have been demanding higher risk premiums on corporate debt as risk-aversion has increased. According to index data by Merril Lynch, the spread that investors demand on corporate debt instead of holding U.S. Treasuries has widened 20 basis points this week to 128 basis points. Investors fear corporate debt will be taking hits from the subprime meltdown.

Currency Outlook and Strategy:
Tomorrow at 8:30 a.m. the U.S. Commerce department is due to release a report on U.S. consumer spending. Economists from a Bloomberg news survey speculate personal spending rose 0.1 percent in June, the least since September. Ever since U.S. personal spending has slowed from a 5-month high in December, the dollar has fallen 3.5 percent against the euro. Even though a weak spending forecast is already factored in the EUR/USD price, there is room for a further fall if the U.S. Federal Reserve decides to lower interest rates. Kenta Inoue, economist and currency analyst at Mitsubishi UFJ Securities in Tokyo, states: “I expect the U.S. economy to slow and the Fed to lower rates in the 4^th quarter. There is still room for rates to rise in Europe, so investors will start to favor European currencies over the dollar.”

And this brings up another question: Will the European Central Bank raise their federal funds rate above the current benchmark of 4.00 percent? There is much speculation the ECB will hold onto the current rate after its next meeting on August 4^th, but is likely to raise rates later in September. This increase may mean further appreciation in the euro, a main worry of French President Nicolas Sarkozy. But recent data has shown an appreciating euro has not hurt the euro-region as a whole. Exports from the EU rose 9 percent in 5 months through May from a year earlier, the second fastest pace in 6 years. This begs the question why an appreciating euro has not hurt exports. The reason is that against the currencies of the EU’s 25 trading partners, the euro has increased less than half as a much as against the U.S. dollar. Exports to the U.S. may have been hurting, but with Germany as the world’s largest exporter, exports to other countries have more than made up for losses.

Another benefit from a rising euro has been lowered costs of oil, which is priced in U.S. dollars. The price of oil has risen 26 percent this year to $76.73 a barrel today. Despite hurting some European corporations like Airbus and Peugeot (charts), the overall euro-region seems to be withstanding the euro impact. The ECB is forecasting economic growth at 2.6 percent for 2007.

Yesterday’s report on the extremely sluggish U.S. housing market sent equities markets crashing, investors dumping corporate debt, and currency traders unwinding carry trades. New U.S. homes sales for June fell 6.6 percent. This number has jumped significantly from the 2.2 percent decrease in May. According to a Bloomberg article, this may be a no end to the real-estate slump. The housing issue has even breached the international level as a report today by the U.K.’s Nationwide Building Society showed home values to have risen only 0.1 percent in June, the slowest in 15 months.

The faltering confidence in the equities markets has also brought shifts in forex. Despite having been on a six-week run against the dollar, the pound took its biggest fall in the last five months. The pound dropped 1.0 percent in one day to $2.0305 at 1:04 p.m. in London from $2.0491 late yesterday. On July 24^th the pound had reached $2.0654, its highest level since May 1981. The pound and the euro also took major hits against the yen, indicating investors are losing confidence in their carry trades with the Japanese currency. Against the yen, the pound fell to 241.27 from yesterday’s close of 243.21. Steven Barrow, chief currency strategist at Bear Stearns Intl. Ltd. in London, states: “There’s a reasonable degree of panic going on with the whole mortgage and credit issue and that has encouraged risk aversion.”

Currency Outlook and Strategy:

The sharp fall in the pound has allowed the 14-day RSI for the GBP/USD to fall below 70. This indicates that a reversal will not come anytime soon. Kathy Lien, chief currency strategist at FXCM expects “room for more losses” in the pound. In addition, traders have taken steps to hedge against the risk of a rallying yen. The cost of options protecting against gains in the yen rose to a 3 year high. This movement of risk aversion indicates a revival in the carry trade may not happen anytime soon. Neil Jones, head of European hedge fund sales at Mizuho Financial Group Inc. in London, states: “Investors are looking for some short-term protection on their exposure to the yen strengthening.”

History has shown us an interesting pattern where the EUR/JPY pair has followed a very similar trend to that of the U.S. Dow Jones Industrial. As the Dow takes hits so does the EUR/JPY. See more on this pattern in an article by FXCM technical currency strategist Jamie Saettele. Overall, the leveraged-buyout financing era has taken a huge fall. There is much uncertainty as investors are shifting their portfolios toward less risky assets. Steve Pearson, chief currency strategist at HBOS Treasury Service PLC in London, reflects: “[The] three year period where financial market volatility has declined to low levels is over.” For now it is best to let the markets react and then change strategy.