Category — Forex Trading

In the days leading up to the European Central Bank’s rate decision on July 3rd, 2008, many political leaders around Europe publically pleaded for the ECB to leave interest rates unchanged. Among others, French President Sarkozy voiced the opinion that the recent rise in inflation was due primarily to the spike in commodity prices.¹ As such, Sarkozy suggested that though hiking interest rates would not really help in lowering inflation, it would adversely impact growth. The ECB went ahead and hiked interest rates anyway, and looking back now, a month and a half later, we can begin to asses two issues: whether the rate hike was the right choice, and what the ECB should do now.

Looking at the statistics over the past few months here, there are several main points to take away. The first is that President Sarkozy’s nightmare seems to have become reality; growth has suffered. In the Euro-Zone, as well as in its three largest economies, Gross Domestic Product (GDP) fell in the second quarter. However, the second chart (showing Consumer Price Index) indicates that inflation has either slowed or halted its rise in these same economies.

Given that the ECB is bound to target inflation first and foremost, the above statistics would imply that the recent rate hike was the correct move – though clearly not without consequences. Inflation has slowed in its rise, and while next months’ numbers will bring about more clarity to the situation, it seems that the rate hike had its desired impact. Now, the more prudent question is if the long-term repercussions of the hike will outweigh the benefits. Will the rate hike facilitate Europe’s slide into recession? It is certainly possible. Italy is already on the brink of recession, and France’s large decline in growth indicates that it is also in trouble.

One important note about the CPI numbers is regarding the source of the recent slowdown in the rise of inflation. As the price of oil started to fall around the same time as the rate hike, it is unclear which – or both – influenced inflation. As it is probable that both events have had an impact, it is unknown just how useful the rate hike has been thus far in thwarting inflation’s rise. However, considering the magnitude of oil’s fall in recent weeks, it is safe to assume that it has had a sizeable impact on the slowing of the rise of inflation. The fall in oil price will help alleviate inflationary pressures anyway; hence the ECB should switch focus to the other problem of falling growth.

At this point, the best move for the ECB would now be to cut rates. While the ECB was founded with an inflation-targeting mentality, it is too dangerous to ignore growth at this time. The US (seemingly) has recently skirted around a recession by aggressively slashing rates and supporting wounded members of the banking system. By admitting the problem early on, the US avoided significant damage to the financial sector, with only one of the largest banks going under. Europe, however, has taken a different path, and now finds itself on the precipice of recession. This proposition to focus on spurring growth comes from the belief that the inflation problem can largely solve itself as long as energy costs continue to fall. With oil prices down over 20% from their all-time high, it seems apparent that this fall in price will eventually be filtered down to consumers.

Proponents of the ECB’s generally “hawkish” nature would certainly throw out economic theories such as the J-Curve to support their position. This theory suggests that through a devaluation, a country can actually increase their trade balance (and hence GDP) via increased exports and decreased imports. There is potential for this to occur, but that would involve a devaluation of the Euro that many Europeans would certainly love to avoid. Furthermore, this process of GDP rising on its own could take an unacceptable length of time. Just recently, the ECB finally admitted the problems that the Euro-Zone now faces.² It is time that the ECB make a bold move and cut rates, sending a signal to the markets that they will not stand by and watch Europe sink into recession.

1. http://www.reuters.com/article/gc04/idUSL3045627720080630
2. http://news.bbc.co.uk/1/hi/business/1388781.stm

Take your emotions out of the picture, that’s what they say. While some investors are able to treat securities in an indifferent manner, few are able to ignore the feelings of greed or fear that come with profits and losses. For people involved in financial markets, finding ways to trade without emotion is one of the toughest and most important tasks that an investor will attempt. The border between human psychology and investing is a shady one, filled with perilous lessons as well as the figurative corpses of an immeasurable amount of investors who have tried – and failed – to ascertain the balance.

The ugly truth of investing? Not everyone is a winner. This is true in almost any market, including the FX market. Even while attempting to strategize without emotion, we cannot avoid our own psyches; we are not machines, no matter how much caffeine we digest on a daily basis. As a result, things that should be certain are often unclear, and things that should be unclear are often certain. Today, Henry Paulson and Ben Bernanke spoke to Congress and presented a mixed bag of information. However, despite the overall optimistic tone of their talks, the US Dollar got slammed across the board, losing about 100 pips against the Euro. So what to do?

The best suggestion that I have learned from dealing in the FX market is to utilize whatever tools possible that push your emotions out of the equation. Personally, I utilize ‘Stop Losses’ and ‘Take Profits’ whenever trading, and perhaps more importantly, I avoid altering them at all costs. Our minds play tricks on us, fostering greed when we’re up, and inducing fear when we’re down. Even for incredibly successful individuals in the business and finance world (i.e. Jerry Yang), removing emotion can be a difficult proposition. However, there is something else to keep in mind: many traders do win. And as long as you are responsible and mature in your approach to investing, there is no reason why you can’t be one of those people who learns to balance psychology and investing.

Upcoming Figures
CAD Net Change in Employment (June)
CAD International Merchandise Change (May)
USD Trade Balance (May)
USD U of Michigan Confidence (Jul)

Fundamental analysis can be daunting, but this is what drives the market. I don’t care how many doji’s or buy signals Deutche Bank saw on the eve of the Russian Debt default. I guarantee they where glued to International news stations not there computer’s technical chart analyzers. That being said, where do traders locate news events that move the market? DailyFX has a great economic calendar to show you what events are coming up and what the numbers are. These numbers move the market and each event is marketed with a simplistic high, medium, low rating as to whether or not traders place trades regarding the outcome

The Fed, the ECB, and the Swiss National Bank (SNB) all have websites. Google them and you won’t be disappointed. I must admit like all things European the ECB and SNB website’s are aesthetically pleasing, but they both hold a plethora of information. The information on these site’s can give you crucial information, easily access statistics and other information that will help you make informed currency trades. The Fed website on the other hand is a lot like the mid-west, boring but full of endless bounty. There is no window dressing and it gives you links to libraries of statistics complied by the (BEA) the bureau of economic analysis. There are the minutes from each FOMC meeting and statements made by Fed Governor’s regarding the feds directives.

All the sites have a mission statement of each central bank, while the Fed’s is more fluid and allows the Governors to tailor monetary policy to each situation. The ECB in stark contrast state in the second sentence of there mission statement underline that they will ensure price stability at all costs. The SNB otherwise known as the central banker’s central bank have objectives are a hybrid like the Fed, they acknowledge that price stability is key but other developments may prevent the feasibility of this objective. Basically the SNB and the Fed are free to conduct responsible monetary policy at their discretion. While the ECB’s independence is mandated by the Maastricht treaty they are treated like children when it comes to monetary policy. Germany made this a pre requisite for signing the treaty because they feared the monetary irresponsibility of there Southern brethren notably Italy and Spain. The ECB must keep inflation below 2%, good luck in the coming years. Good for traders to know because over the last year the Euro has killed the dollar. I’m not going to give you a homework assignment that will benefit you in your trading but if I’m placing money on the Euro, US dollar, or Swiss franc then I’d want to have an intimate relationship with their central banks.

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)

Euro zone growth has exceeded the US contributing to the appreciation of the euro but after a closer look the EZ doesn’t look that healthy. Essentially Germany has pulled the Euro Zone forward for the past year while the PIGS otherwise known as Portugal, Italy, Greece, and Spain have stagnated or gone in recession. So to answer my own question, I seriously doubt the Euro will break 1.60 if Germany stagnates. The German current account was reported on Monday and it was slightly lower than expected at 14.5 billion instead of 14.7 billion expected. It is a small gap but the number that should alarm traders is the fact that the current account dropped by 3 billion from the previous month.

Does this point to a trend? Are high exchange rates hurting Germanys export lead growth? Perhaps and this will weigh on the ECB come June when they make their rate decision. The engine to European growth may be running out of gas, and the PIGS are not going to rescue Europe in the future sp we can look for a lot of range trading between 1.50 and 1.60.

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.