Good Morning, Friends. One of the reasons that I found the transition from graduate school in European history to a bank trading desk congenial is that I have a (roughly) three minute attention span. That turned out to be appropriate for working in the currency market, particularly when I started back in the mid-80s. One of the side effects of this quirk (my wife has other, less benign designations for it) is that I tend to glance at a fair number of articles as I’m making my way through the morning gruel, and occasionally two or more pieces stick together in a way that suggests a potential strategy or trade.
“The Economist” arrived late this week, but a glance at the “Buttonwood” column this morning reminded me of something that I’ve mentioned here on occasion: a portfolio composed of currencies with higher nominal interest rates will generally outperform one with lower nominal rates, even though it should be the real (after inflation) interest rate differential that matters. If you’re interested, the article is titled “Carry on trading”. This phenomenon, of course, is the basis for all carry trades.
From “The Economist” I segued to the essential “Financial Times” with a couple of swipes on the iPad. One of the headlines announced that President Pena Nieto of Mexico has proposed opening the national energy monopoly, Pemex, to outside investors, something that will require a change to Mexico’s constitution. Outside capital and expertise will help Pemex to supplement its current production, and maintain Mexico’s status as an oil exporter. Revenue transfers from Pemex are also an essential component of the Mexican government’s finances; more would be considered better.Â
An e-mail from my friend (and former Reuters colleague) Neal Kimberley, whose columns at Reuters.com I recommend, mentioned his surprise that the market hasn’t responded more forcefully to what is potentially a very significant change for the Mexican economy by buying MXN. Â Most of us would accomplish this by selling USD/MXN. There is some risk to that trade from possible changes in fundamentals; if the 3-month interest rate differential were to narrow, that would be a negative, and of course a failure to amend the Mexican constitution would be a real blow. Still, Pena Nieto’s PRI controls the government, and despite opposition, the betting seems that he will get the needed legislation passed. The Fed seems highly likely to keep short term rates at zero for the next year, and perhaps longer, while the Banco de Mexico is expected to maintain the benchmark rate at 4%.
There thus appears to be a plausible fundamental case to be made for a short USD/MXN position, but we trade technically here (although I do encourage everyone to have a grasp of the fundamentals; if nothing else, it makes getting blindsided by headlines less likely). The daily chart, which I’ve added at the top of this post, shows a fairly recent downtrend that has bounced to a potentially salable point (around 12.8920), but which has since failed to gain much downside momentum, as the recent low at 12.4294 hasn’t been seriously threatened. The pair is currently around 12.75, and something above 12.82 looks like a reasonable level to start building a position. I’d be wary if 12.89 broke to the upside, and although I wouldn’t necessarily give up on the idea of a short USD/MXN trade, I would likely square up and reassess were the level to give way.
The initial downside target would be 12.55, I think, the extent of the recent downside move off the bounce, and then the previous low at 12.4294. These numbers may seem large, but the Average True Range is around 13 big fitures (0.1300) at present, so a move of 2500 or so Peso points is conceivably the work of just a couple of days. Today’s range, for example, has been just over 13 big figures (12.6507 to 12.7835). Someone who captured the day’s entire range (short at 12.7835, covering at 12.6507) would be up $1,050 on a $100,000 position (and, of course, vice versa). No, it wasn’t me; I have no position at present, and am just watching.Â
Despite the favorable fundamental backdrop, and what I would consider to be no worse than a slightly positive technical setup, this isn’t a no-brainer; there are several moving parts, and any indication, in particular, that the Mexican government was shying away from permitting outside investors in Pemex could be painful. That’s part of my desire to wait for a better entry rather than just hitting a bid. As Orson Welles used to say, “Good things sometimes take time” although he was talking about wine.Â
By the way, I would encourage those looking to trade currencies to familiarize yourselves with the nuts and bolts of the market, rather than simply looking for “good charts”. TradingConcepts, of course, periodically offers FX training, which would be very beneficial, but at a minimum, I would suggest studying a copy of Cornelius Luca’s “Trading in the Global Currency Markets”, now in its third edition. We gave it to all trainees at my old shop, and it will help to give you a sense of why the dominant players in the market behave in the ways that they do, and what they look at when analyzing trades.
Best of luck!
Join Over 84,750 Traders Receiving Our FREE Daily Trading Videos