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Category — Forex Trading
Bank of England Rate Hike Likely
The most important news today (at least in terms of the foreign exchange market) is the release of the minutes of last month’s BoE Monetary Policy Committee meeting. The release surprised most of the market with a more hawkish-than-expected stance. The Committee did vote to keep interest rates steady in June, but the vote was much closer than many traders had predicted. Most market analysts had expected a 7-2 vote against a rate hike last month, but the actual vote was 5-4.
In addition to that, Governor Mervyn King was one of the four dissenters calling for a rate hike. The bank’s governor has only been overruled twice in the 10-year history of the Monetary Policy Committee. Many traders today feel that with King now calling for a rate hike, the decision is almost a done deal. Today’s release of the meeting’s minutes only confirms forex market speculation that began with hawkish comments earlier in the month by Governor King and others.
There are other important currency market considerations regarding interest rates besides the comments of the Committee members. Money supply growth has reached its fastest annual pace in seven months. Oil prices are still at $69/bbl. Other inflation indicators are also robust, including the British housing market and the index of prices in shops.
It is difficult to predict the actual actions of central banks (that doesn’t stop currency strategists from trying). But the various exchange markets have already felt the impact of the release of the Committee vote. Futures market traders are betting on a rise in rates to 5.75% at the next meeting. In the forex market, the future rate hike is being priced into the value of the pound right now. For example, GBP/USD easily cleared 1.9900 after today’s minutes release, and it is likely not to encounter much resistance at 2.000. The pound has also risen against the Japanese yen, climbing to its highest level since 1992. Look for strong support for pound long bids in the coming day as the forex market prices in the likely BoE rate hike.
June 20, 2007 No Comments
Carry Trade Momentum Grows
The yen carry trade remains strong in the foreign exchange market, but before analyzing why that is the case, let’s look at some specific exchange rates. The US dollar has fallen in recent trading versus the euro (EUR/USD) and the pound (GBP/USD). Bond yield in the US have declined from their record highs. Home builder confidence is at its lowest in sixteen years. And the CPI numbers last week (with core prices rising only 0.1%) demonstrate the slowing pace of inflation. Put those factors together, and you get weak support under the dollar.
The pound and the euro, however, continue to receive strong bids in the currency market. Much of this has to do with a growing consensus among traders concerning the likelihood of a rate hike by both the ECB and the BoE. President Trichet of the ECB recently came out and said the new emergence of many fast-growing economies around the world is creating a upward pressure on prices. These hawkish comments were coupled with remarks by other ECB members asserting the ability of other European economies to withstand a future rate hike.
The flipside of this strength is the persistent weakness of the Japanese yen. There is optimism among Japanese policymakers (after the GDP and Industrial Production data), but the growth is still not robust enough to survive higher interest rates. This is especially true with regard to the Japanese consumer. And the low interest rates in Japan prove irresistible to carry traders.
Take the EUR/JPY pair. It hit an all-time high of 166.12 yesterday eventually settling at 165.91. The euro-yen has been a one way bet recently, and the tame US inflation reports will keep it that way. The carry trades are unlikely to be interrupted in the near future considering the low risk of global inflation in the current currency market. The US inflation data signals lower volatility in international exchange rates in the future. So traders have more confidence that they can capture the differences in yields in two countries without the risk of losing those gains thorough market swings in the exchange rates.
But there is one important caveat for enthusiastic carry trades. BoJ governor Fukui has said that it is important for the country to raise real interest rates to help domestic pension plans. There is also a concern for political repercussions in Europe and the United States if the continuing devaluation of the yen proves to be too much of an advantage to Japanese exporters. Lastly, 10 year bond yields in Japan have reached 1.935%. Yield levels of 2.00% or higher could lead to a return to the domestic bond market for Japanese institutional investors. That by itself could push the Japanese currency up, destroying carry trades.
June 19, 2007 No Comments
Follow the Yield
The defining action this weekend had traders basing their decisions almost entirely on yield differentials between countries. In many cases, broad economic data was ignored in favor or inflation expectations and interest rates. That’s why it is so important for foreign exchange traders to study the futures charts and determine which central banks the market thinks are likely to raise interest rates. Example number one is the state of the US dollar. Friday’s CPI report drove the market for the dollar. Core prices rose only 0.1% in May, signaling that inflationary pressures were under control and in line with the growing economy. As such traders in the forex market see no reason for interest rate hikes in the near future, and the dollar has suffered as a result.
The Japanese yen and the Swiss franc have also fared poorly in the currency market mainly due to interest rates. The economic situation in Japan and Switzerland is completely different. The Swiss economy is robust and growing at a rapid pace, while the Japanese economy, despite satisfactory GDP growth, still has to contend with weak consumer demand. Yet both currencies are experiencing a similar freefall; low interest rates in both Japan and Switzerland make carry trading especially attractive.  The Bank of Japan not only did not raise rates in their meeting last week, but its comments suggested that it was unlikely to raise rates next time either unless consumer demand picked up. The Japanese economy is simply not ready for interest rate hikes.  In Switzerland, despite much stronger economic data, the SNB chose to only raise rates by 25 basis points. This did not do nearly enough to cut the rate differential between the franc and the other European currencies.
The situation is only exacerbated by the possibility of interest rate hikes by both the Bank of England and the European Central Bank. The currency market is loading up on both the pound and the Euro in anticipation of in anticipation of those future rate hikes. Hawkish comments about inflationary pressures by European Central Bank council members continue to bid up support for the Euro (EUR/USD at highest in two months) despite poor Industrial Production and Retail Sales data. In England, BoE Governor Mervyn King is as hawkish as ever concerning rising inflation. The likelihood of rate hikes is being priced into both currencies, leading to gains across the board, especially against the US dollar, Japanese yen and Swiss franc.
June 18, 2007 No Comments
Yen Sinks—But Dollar Falls Too
The Yen was hammered last night in the forex market. In the Bank of Japan meeting there was a decision to keep the overnight lending rate at 0.5%, the lowest among all the major currencies. All the major currencies increased against the Japanese yen as it became obvious that rate differentials were not going to compress. But as Boris Schlossberg of DailyFX.com points out, the losses probably had as much to do with the bank’s reluctance to commit to a rate hike in August as they had to do with today’s decision. The policy makers in Japan admitted that they were more worried about the still-lagging domestic consumer demand than they were about the admittedly undervalued currency.
Carry traders continue to rejoice with the non-move in interest rates. With no danger of a US rate cut, USD/JPY reached a fresh 5-year high. There is cause for some worry for carry traders in the currency market. The undervalued yen has led to an advantage for Japanese companies overseas. There has already been complaining in Europe about this advantage. If policy makers in the US jump on this bandwagon as well, it could lead the BoJ to institute a preemptive rate hike.
Going back to the dollar, there are a few signs of continuing dollar strength. On June 14, we saw PPI numbers that positively surprised the forex market. Almost all recent data that has come out the US has been higher than expected and supported dollar bids. And in the last week, high bond yields have continued to suggest an interest rate hike by the Fed.
But today’s data shows creeping signs of dollar weakness. Home mortgage rates last month reached record highs, as did foreclosures. With that kind of negative push on the US economy, it might be unwise to raise rates at the time. In addition, today’s CPI report came in surprisingly tame, with a lower-than-expected rise in prices. Production at factories, mines and utilities declined last month, and consumer expectations have been underwhelming. A repeat of this kind of performance in coming days might give the Fed some cover for a rate cut. And it is that fear that allowed EUR/USD to gain so strongly yesterday.
June 15, 2007 No Comments
Dow Rebounds: What Does It Mean for the Carry Trade?
The US stock market rebounded from recent lows yesterday. The Dow rose 187 points, and that has a significant effect on the international currency market. This is especially true with regard to the carry trade, specifically, with regard to the Japanese yen-based carry trade. Through the years, technical analysis comparing the forex market with the equities market has shown a long-term positive correlation between the carry trade and the stock market (more on the relationship between the carry trade and the Dow).Â
           The stock market rose on the back of this month’s Beige Book Report, which was slightly more optimistic than last month’s report. The relatively decent condition in all the Fed districts gave many traders a reason to invest. And as we would expect, carry trades took off yesterday. The Yen currency crosses rose, with the USD/JPY hitting a four year high and the Australian dollar was up to a 15 year high. As the Dow continues to rise (and there’s no reason it should stop), this should support the carry trade and drive the Yen lower.Â
           But investors should be wary of uninterrupted gains through the carry trade. Goldman Sachs Groups Inc. has just issued a notice for carry traders, warning of higher volatility upcoming in international markets. This volatility would not only be evident in the stock market, but in the currency markets as well, proving disastrous for carry traders. There is a feeling among some forex traders that we are approaching a bottom in volatility. Of course, for a one-way bet like the carry trade, low volatility is essential for continuing positive returns. But we might be approaching the mature end of the current growth cycle, and history has proven that traders have had difficulty predicting monetary policy at these times.Â
           There are examples of this in recent forex market developments. Traders in both the US and Canada have been moving back and forth in the futures market on the subject of rate hikes or rate cuts. Speculation has been rife on future policy changes by central banks in Asia, Europe and the Americas. A return to high volatility in either equities or foreign exchange could spell the doom for carry traders. In the end, the carry trade should be a viable strategy for now, but traders should not hope for positive gains forever.Â
June 14, 2007 No Comments
US Dollar Bulls Rule
US Dollar growth is the primary market mover today. Bonds continue to fall in the US, driving yields to their highest level since 2002. And that has significant repercussions for all other currencies in the foreign exchange market.Â
Despite strong economic data for the yen, the strong dollar growth continues to dominate. Japan came out with great e data yesterday as the current account surplus blew past expectations of 1948 billion yen, arriving in at 2279 billion yen. The weak yen proved beneficial to Japanese exports. But US bond yields are at their highest level in five years causing Japanese investors to continue to buy US bonds, for which they need US dollars. So despite the positive economic results in Japan, in the forex market, USD/JPY continues to be bought, keeping it above 122.00.Â
In Europe, the Euro has been sold for seven straight days now, putting it at a new two-month low against the dollar. This is on the basis of not only overall dollar strength but also bad economic data. As we stated previously, industrial production in Germany and France has plummeted. But despite the data, the European central bank has continued to be hawkish. If the ECB follows through on its rate hike promise, or at least if the market believes it will follow through on the promise, then that could limit dollar growth.  It is important in the currency market because the Fed is certainly not going to raise rates at its next meeting.
In the UK, we also have evidence of broad dollar strength. But the pound has done well against the dollar in past couple of days, on the back of a narrowing trade deficit and a very slight rise in core price inflation. But today’s slower than expected wage growth has put a slight hold on the Bank of England’s plans for a rate hike. When combined with the bid support under the US dollar, that has driven GBP/USD under 1.9700.Â
The Australian, New Zealand and Canadian dollars also suffered yesterday. The strong dollar was a factor, but so was the decline in carry trading. With the US stock market falling again, carry traders were looking to liquidate. Markets are interlinked, and if the current condition in the US equities market continues to hold, then that could put a damper on carry trading.Â
It certainly looks as thought the rise of the US dollar will continue for now. This morning, US retail sales rose 1.4% beating estimates of 0.7%, and last moth’s sales data were revised upwards as well. Import prices did rise, but that was expected considering the weak US dollar in April and May. The sales data demonstrates that consumers are hanging in there, and that is definitely bullish for US yields. As long as the US consumer continues to hold off his long-predicted fall, dollar bulls will continue to rule the market.Â
June 13, 2007 No Comments
Asian Currency Intervention
The Reserve Bank of New Zealand intervened in the foreign exchange market on the morning of Monday, June 11, 2007. The central bank felt that the currency was at an unreasonable high level. So it used a taxpayer-supported fund to sell the New Zealand dollar in the foreign exchange market. The Kiwi fell 100 points in early morning trading as a result of this action. The currency had risen in recent days to a 25-year high against the dollar and a 17-year high against the yen on the back of a surprise rate hike by the RBNZ on June 7. The hike, and the hawkish comments that accompanied the hike, moved the Kiwi to a level that the bank found dangerous. Today’s comments characterized last week’s highs as “exceptional and unjustified in terms of economic fundamentals.â€Â In New Zealand’s export-driven economy, the unreasonably strong currency was starting to put an check on economic growth. Early reports estimate that the RBNZ spent about 120 million US dollars intervening in the foreign exchange market. There is strong precedent in Asia of active intervention in the curry market by central banks.  As such, this morning’s actions should serve their purpose of weakening the Kiwi (at the very least, the bank’s actions demonstrate the upward limit that the RBNZ will allow for the Kiwi to appreciate).Â
           The RBNZ’s forex market intervention will have wider market repercussions as well. Because of the large borrowing rate differential between New Zealand and Japan (8.00% to 0.5%), this currency pair has seen rampant carry-trading. The Japanese carry trades have had a substantial influence on trading markets generally, with yen borrowing as a primary vehicle for foreign investment in the US equities market. But this RBNZ intervention this morning could cut into carry trading momentum. If the forex market follows with the talk of the New Zealand central bank push to depreciate the Kiwi (and it has a history of moving with the bank), then that would be a minus for carry trade and a positive for the yen. The risk of carry trade unwinding is not as much of a concern as it could be. There is a sense that the Japanese market could sustain the natural tightening that a stronger currency would inflict on an export-driven economy.  The important thing is to watch out for the larger implication of this Asian currency intervention, not just its direct effect on the Kiwi.Â
June 11, 2007 No Comments
AUD/USD Pushes Further Toward Seventeen Year High
After passing the ten year high set recently the AUD/USD’s next mission is to break the December 1996 high of .8215 to seek levels set in October of 1990. Retail sales came in better than the expected .8% m/m at .9% m/m causing the pair to rally around 100 pips.
April 2, 2007 No Comments
Carry Trade Liquidation – How much will it unwind?
There is one question on the mind of most currency traders, and that is whether the carry trade liquidation is over.
Last Tuesday we saw the start of the global carry trade liquidation, with the Shanghai Stock Exchange closing approximately 9 percent below the open. This sell off was suspected to be started by speculation on whether the government will implement a capital gains tax of 20 percent in the upcoming fiscal year. The tax would have a negative effect on investors causing them to shy away from speculation with both personal and borrowed money. However, after investors determined that the tax was not going to be heavily enforced, the market began to show signs of a rebound. Nevertheless, the damage had been done, and the worried currency traders that were short the Yen became much more risk adverse, and resulted in traders closing their Short yen positions. This process has led to the strengthening of the Yen against almost every cross.
Over the course of the following week we have seen several major revisions in the exchange rates. The yen was able to realize approximately a 13 percent gain against the US dollar as the equity markets scoured. The market crash resulted in an unwinding of carry trades that resulted in the biggest weekly gain in the Japanese Yen against the US dollar in 14 months. In addition to the dollar, the yen increased 9 percent in value against the New Zealand Dollar, giving back almost 4 months of progress. The major factor that most people will be watching in these currency pairs is not whether they will retrace, but rather will they continue to decline before that retrancement occurs. The major event that traders will be keeping their eye on to help make this determination is unemployment numbers – Non-Farm Payroll – this Friday.
March 7, 2007 No Comments
Head and Shoulders
We have an early head and shoulders formation on the NZD/USD monthly chart. Many would wait until the bottom of the shoulder before taking a short, but even if you target the middle of the shoulder you have about a 400 pip move possible.
Beware this trade could take a while to develop as we are looking at a monthly chart and the carry is against you on this trade.
Definition: Head and Shoulders
February 14, 2007 No Comments
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