Category — Forex Trading

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.  

As the U.S. dollar fell to record lows against the euro last week, technical analysis may indicate an earlier than expected rebound in the short run. Last week traders speculated long-run rebounds due to the U.S. economy benefiting from a weak dollar and from pressure on the ECB by Nicolas Sarkozy to cool a strengthening euro. But as traders have been eyeing the Relative Strength Index (RSI) on the EUR/USD pair, there is a possibility of a short-run rebound.

The RSI measures the strength of a currency pair price movement typically within the past 14 days. When the RSI is over 70 there is a good chance the price movement will fall. At over 70 most sellers who have been looking to sell perceive the current price to be the best price. On the other hand, buyers will likely wait for the price to fall when the RSI is in fact over 70.

Thus, in the context of the current EUR/USD pair, the RSI is at 76.34 today hinting at a future fall in favor of the dollar. The U.S. currency did in fact make a small gain to $1.3817 per euro this morning. This level is up from last week’s record low of $1.3845, but not enough to indicate an actual rebound. Nevertheless, the high RSI value may indicate a rebound sooner than expected.

Currency Outlook and Strategy:
On July 25^th, the National Association of Realtors is due to report figures on last month’s existing U.S. home sales. It is expected that U.S. existing-home sales have fallen the lowest in 4 years. This could further hurt investor confidence in the dollar. Looking across the Atlantic, European Central Bank Executive Board member Lorenzo Bini Smaghi states he is not worried about euro appreciation. But Nicolar Sarkozy, newly elected French President, thinks otherwise.

Tim Shea, currency analyst at FXCM, concludes: “This week in the Euro looks very quiet news-wise. We’ve got next to nothing on the European calendar, and pretty much just housing data and GDP in the USA. So, watch the housing numbers and the Dow for some direction, and don’t forget about $75 per barrel oil.”  

The Chinese economy has grown at its fastest rate in 12 years during the second quarter. China’s GDP growth has increased to 11.9 percent from a year ago. This figure has exceeded all expectations from 23 economists at Bloomberg. Inflation has risen to 4.4 percent in June, the fastest rate since September 2004. The Chinese economy is on fire and needs cooling. The most obvious is a change in monetary policy. There is much speculation the Chinese central bank will increase interest rates and in turn this will strengthen the yuan. But is revaluation by direct policy of the yuan needed?

According to Glen Maguire, chief Asia economist at Societe Generale SA, a strict revaluation by the central bank is needed in order to quell the surge. He indicates the yuan may even need to appreciate as much as 3.5 percent in a single day. A stronger yuan would slow down the economy by making exports more expensive and thereby reducing China’s enormous trade surplus. U.S. lawmakers have been very keen on a strengthened yuan, claiming that U.S. companies have been taking hits by its artificially low value. Senator Charles Grassly has spoken on the issue extensively stating the Chinese currency has not risen fast enough.

Despite U.S. and Chinese economists having met and agreeing on the same direction for the yuan, the Chinese central bank does not want a fast acceleration. Bank of China Governor Zhou Xiaochuan has stated he does not want the yuan to accelerate nearly as fast as the U.S. would prefer. Other currency analysts do not see the yuan appreciating to unprecedented levels anytime soon. According to Tim Shea, a currency analyst in the Sales and Trading Department at FXCM, “China has shown since the initial dropping of the peg in 2005 that the strengthening of the yuan would happen gradually and at their own pace.” He points out, “…that a 3 percent change in one day would be a move of 2200 pips, the equivalent of all the movement made since January. This would not be in line with past policy.”

We have also seen changes in Chinese fiscal policy to help the cooling process. Inflation has actually outpaced the return on bank deposits spurring investments in the equities market. The benchmark CSI 300 stock index for the Chinese market has gained 87 percent this year. In response, fiscal measures have included legislation allowing the 20 percent tax on interest income to be reduced or even taken away. As a result, fixed-income investments have increased to 26.7 percent in the first half of the year from a year ago. Even though this increase in savings is modest in comparison to the spurring equity run, a future meltdown of the Chinese economy is unlikely. With the right fiscal and monetary policy the Chinese economy will continue to grow at a controllable pace. The yuan will strengthen, but most likely at a pace unsuitable to U.S. lawmakers.

FX Week just announced their e-FX awards for this year.  FX Week is a trade magazine for the forex market that focuses mainly on institutional investing (banks, funds, etc.), but there’s something for retail investors as well.  They give out these awards every year to recognize those companies in the industry who have the best electronic presence and services for their customers. 

            Any company working in e-FX could have been nominated for an award.  And with FX Week recognized as the preeminent weekly paper for the forex market, its yearly awards confer to its recipients a recognition of excellence.  Those who win an e-FX Award have set themselves apart from their competitors and demonstrated to their customers the quality of their offerings.  So without further ado, here’s a list of this year’s e-FX Award recipients (broken down by category:

THE WINNERS

* Best electronic brokerGFI
 
* Best trading technology vendor

Currenex
 
* Most innovative bank e-trading platform

Deutsche Bank
 
* e-FX initiative of the year (bank)

Citi
 
* e-FX initiative of the year (vendor)

FXMarketSpace
 
* Best post-trade services to clients

UBS
 
* Best vendor for post-trade services

DEALHub
 
* Best professional e-trading venue

FXall
 
* Best algorithmic trading technology (bank)

Credit Suisse
 
* Best algorithmic trading technology (vendor)

FlexTrade
 
* Best retail platform

Saxo Bank
 
* Best liquidity outsourcing service

Deutsche Bank
 
* Achievement Award

Lars Seier Christensen and Kim Fournais
Saxo Bank
 

Congratulations to everyone!

As U.S. interest rates remain unchanged at 5.25% for the 8^th straight Federal Reserve meeting, and as terrorist arrests in London spur worldwide concern, the U.S. dollar has dropped against major currencies. The dollar fell 0.5% to 1.3605 per euro and 0.6% to 122.44 yen. Investors have become more risk-averse with the recent geopolitical events. As a result, demand for the yen and the swiss franc, a haven for security, has increased. According to Derek Halpenny, senior currency strategist at the Bank of Tokyo-Mitsubishi UFJ in London, interest-rate differentials will continue to move against the U.S. dollar as a result of the unchanged U.S. monetary policy.  

This trend may continue in the long run. Despite recent positive reports of increased retail sales and job growth, investors are worried that losses from hedge funds owning subprime mortgage bonds will slow economic growth. This increase in risk aversion has caused an increase in holdings of risk free debt. Treasury holdings are at 35% of funds overseeing $315 billion in bonds. This is 1% higher than holdings in corporate and sovereign debt for the second consecutive week. In the previous month for the first time in a year, U.S. treasuries have outperformed corporate and emerging-market bonds.

Investors like Bill Gross of Pacific Investment Management Co. are speculating that the housing slump will restrain the economy for the rest of the year. The subprime mortgage crisis is the worst since 1991, and the effects may even be felt next year as well. Investors are speculating that the Federal Reserve will be forced to lower interest rates in the long run in order to induce consumption.

What will lower interest rates mean for the value of the U.S. dollar? Lower interest rates will cause a drop in the value for the U.S. currency. If the Fed does in fact decide to lower interest rates, in the attempt to avert further dampening effects on the economy by the housing meltdown, currency traders will decrease demand for the U.S. dollar. A decrease in demand in will bring down the value of the currency.  

The United States Federal Reserve’s interest rate announcement and accompanying statement is scheduled to be released today at 2:15 PM Eastern Standard Time.  Barring a complete surprise, the Fed is likely to leave interest rates at 5.25% and issue a statement hawkish on inflation.  With contradictory data regarding economic growth and interest rates, the bank cannot do any more.  A move in either direction would prove harmful.

Economic growth in the United States is actually rather sluggish and does not bode well for the US dollar.  In today’s GDP report, we saw that the economy grew 0.7% in the first quarter of 2007, the slowest pace in four years.  This number was higher than the estimates last month of 0.6% but lower than the forecast of 0.8%.  The economy certainly is not growing at the pace it was last year, when the last quarter of 2006 registered growth of 2.5%.

Various sectors of the economy have felt the effects of the economic slowdown.  The housing market is undergoing it biggest slump in two decades.  Demand for housing seems to fall with every new report, and the sub prime woes have led to the number of foreclosures reaching record highs.  Consumer spending, which makes up the largest portion of the US economy, is cooling, mainly due to higher energy prices.  Its growth this quarter is half what it was last quarter.  Business investment is also falling, suggesting that the slow growth this quarter may not be an aberration.  Yesterday’s durable goods report showcased a larger than expected drop in May.

But even considering all this bad news, the FOMC cannot lower interest rates to stimulate the economy.  And the reason why is rising inflation.  Prices continue to rise, at a pace with which the Fed is certainly not comfortable.  Today’s numbers showed a 2.4% rise in core inflation, stripping out food and energy costs.  That is certainly discomforting to policy makers, especially compared to the 2.2% rise that was expected.  And when you consider that the Fed under Chairman Bernanke has professed to prefer inflation within a 1-2% range, you further get the sense that inflation is a big worry.  That is why interest rates are not likely to change, and the statement from the Fed is bound to be tough on inflation (Kathy Lien has a more detailed discussion of the Fed’s decision on interest rates).

What does the Fed’s announcement mean for the US dollar?  The cable should continue to rise, especially in anticipation of the likely interest rate hike in the next BoE meeting.  GBP/USD should not have much trouble staying above 2.000.  The euro should see some gains as well, with similar expectations on the interest rate decision of the ECB.  The yen is a little bit more interesting.  With core prices falling yesterday, the country’s battle with deflation is not yet over.  As long as the Fed remains consistently hawkish in its statement, we might see a reversal of yen gains against the dollar with USD/JPY testing 125.00 soon.

Both U.S. and European equities markets have taken a fall with the news of disappointing durable goods and weak new homes sales still fresh in trader’s minds. The European Dow Jones Stoxx 600 Index fell 0.8 percent to 386.38, the Euro Stoxx, decreased 0.8 percent, and both the U.S. Dow Jones Industrial and S&P 500 fell 0.4 percent.  

The fall in U.S. and European equity markets have pushed forex traders to buy Swiss francs. The franc has gained on the euro for the fourth straight day. Against the euro, the franc is up 0.2% to 1.649, the strongest since June 8^th. Diminishing confidence in the U.S. and European equities have sent investors are looking for security. As in the past, as general risk aversion increases, the Swiss franc gains in value as well as more investors are looking for a low risk investment. With a weakening of the European market, long euro positions have been liquidating and flooding the market for Swiss francs.

Other factors that have contributed to the rise in demand for Swiss francs include news of increasing borrowing rates by the Swiss National Bank. This increase in turn makes a currency more attractive in value as room for arbitrage is created against another currency with a relatively lower borrowing rate. The European Central Bank has also indicated a desire to further increase interest rates to combat inflation which will likely hurt their already weak equities market.

The Canadian dollar reached a 30 year high at 94.79 U.S. cents. Even though it has fallen since, an increase is still possible after today’s U.S. government report showed a decrease in new home sales 930,000 in April to 915,000 in May. New homes were sold at a median price of $236,100, down .9 percent from a year ago. Due to this decrease there has been reason to believe that the U.S. Federal Reserve will begin cutting interest rates causing investors to be prone to selling the U.S. dollar allowing the Canadian dollar to gain.

Further Canadian dollar gains are very possible, but it is important to be aware of the other factors affecting currency fluctuations. As Canada and the U.S. have a close trade relationship, a slowing U.S. economy could spill over into Canada resulting in a Canadian dollar could losing ground to major foreign currencies such as the euro and the pound.

Additional factors affecting the value of the Canadian dollar are crude oil prices and Central Bank lending rates. Crude oil prices have been declining and could hurt gains made from the U.S. housing report. Due to the fact that oil makes up half of Canada’s commodities exports, decreasing oil prices will hurt the Canadian economy. This in turn will make its currency less valuable. Lastly, there is still uncertainty as to whether the Canadian central bank will raise lending rates for its currency. On May 29^th this year, the central bank had announced a possible increase in rates because inflation was not at the target level. However, this change has not happened yet as the lending rate has continued to be at 4.25%, the same since May 2006. The Canadian dollar will see a short term gain with news of slowing new U.S. home sales, but it remains to be seen whether it can maintain this gain in the long term.

Recent developments in the foreign exchange market prove that it is not just interest rates that drive action in the currency market.  Expectations of future interest rates also matter.   The currencies with the greatest chance of higher short-term interest rates are the currencies receiving the most support from traders.  The few currencies with bad prospects for an interest rate hike are getting hammered, and that will continue as long as expectations stay the same.  Just look at the results in the last 24 hours.  The pound and the Aussie have been the best performers while the Japanese yen continues to sink.

Much of this kind of activity is indicative of a strong carry trade.  Economic policy makers in Japan have been clear in their refusal to raise rates, at least until there are stronger signs of consumer recovery in Japan.  And when the Bank of Japan does start raising the overnight lending rate, they have committed to doing it as gradually as possible.  Japan’s rates are low, and people (investors) are encouraged to seek higher yields.  The can find those higher yields in other currencies, in the US stock market (witness the steady resilience of the market to any drops) and in foreign bonds.

The carry trade is simply an interest rate differential story.  There is a concern as it becomes more popular because that makes it inherently riskier (see Bloomberg’s stories on Japanese and Hungarian housewives engaging in the carry trade and beating the market).  But until the carry trade bet becomes untenable (and that will happen at some point), forex traders continue to reap their gains and push the yen lower.  The euro is at its highest level ever again the yen.  AUD/JPY is at a 15 year high and USD/JPY is at a 4 year high.  And perhaps most interestingly, the New Zealand dollar, the currency with the highest yield, is back to the rarefied levels it occupied before the RBNZ intervention.  The bank would like to push it down again, but it is running out of funds.  And central bank interventions do not usually work anyway.  The bottom line is that as long as the global market stays calm, carry traders will profit on the interest rate differentials.  But world-wide inflation, political uncertainty, a slowdown in the United States or anything else that throws the forex market into flux will put a wet blanket on the carry trade.

Carry trades are still a ubiquitous feature of the forex market, but the driving force in the market today is not Japanese interest rates.  The ten-year US bond market has been the largest influence on international currencies.  The bond market has suffered recently, and the high yields have provided crucial support for the US dollar.  Especially with little US economic data on the docket for this week, currency traders are increasingly relying on yields to make their bets.

Yesterday, the US dollar gained ground against the Japanese yen, the euro and the Canadian dollar while losing ground against the New Zealand dollar, British pound and the Swiss franc.  The most interesting part of that scenario is that, with the exception of the Swiss franc, the dollar gained against every currency over which it had a yield advantage and lost against the currencies that had a yield advantage over it.  What we should ask ourselves is why US bond prices continue to fall?  Unfortunately, there is not a clear cut answer to that question.  But it might have something to do with the sub prime mortgage loan crisis in the United States, typified by the shutdown of two large hedge funds by Bear Sterns.

The effects of this on the currency market are startling.  While carry trades are in play, much of the momentum for the USD/JPY growth is certainly coming from high US yields.  With 10-year bond yields again reaching 5.15%, the forex market is simply shrugging off most other economic news.  Wednesday’s European economic data was actually pretty heartening.  PMI readings, especially in manufacturing, were better than expected, but the euro still fell against the dollar, as US yields determined the action.

The general situation repeated itself this morning.  The Federal Reserve Report for Philadelphia came out, and there were more first-timers on the unemployment rolls.  But the rest of the data was strong, with manufacturing picking up after a long layoff.  But the movement in the currency market was dollar-negative.  The US dollar lost most of its gains versus the Japanese yen and the Euro on the basis of falling bond yields.  The Germany IFO Business Climate Report is scheduled to be released at 4:00 PM today, and the data is likely to be positive.  But if recent forex activity has shown us anything, it’s that what happens to US 10-year bonds will matter more when it comes to currencies.