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Looking for a Move Down, Down Under

Players in the FX and other markets have become accustomed over the past couple of years to identifying trading environments as “risk on” or “risk off”. The “risk on” days are characterized by rising stocks, lower bonds, precious metals meandering to down, and the Dollar, Yen and Swiss Francs getting sold versus most other currencies. The “risk off” variety tends to see stocks down and bonds up, with the safe haven currencies (USD, JPY, CHF) happily bought, along with precious metals. Very broadly speaking, “risk on” days tend to correspond to data points that suggest that the global economy or its main drivers (the U.S., the Eurozone and China) are likely to expand, while “risk off” days signify the reverse. The market isn’t always consistent about the triggers, but the results tend to be fairly predictable. Of course, recently “risk on” and “risk off” days have switched back and forth quite rapidly.

Those students who saw Todd and Craig’s recent seminar on managing volatility will recalll that one of the suggested techniques was to step back, and take a look at broader timeframes. Since academics and practitioners actually agree that currencies exhibit identifiable trending properties, this makes sense for currencies in any case. The methodology that Todd teaches, I’ve found, works well across time frames and asset classes, and I’ve come to use his techniques in identifying currency trades and then managing them once they’ve been entered.

I was looking through daily charts of currencies this evening, and found one that looked interesting; the “risk on” Australian Dollar vs the U.S. Dollar (AUD/USD). Aussie on the daily chart hit a recent high of 1.1081 on July 27, and by August 9 had dropped a substantial 10.4% to .9928. The Australian Dollar, which offers a yield roughly 3.5% higher than the USD on an annual basis, tends to become very crowded in “risk on” environments; when traders hit the exits , it’s often in reponse to a negative economic report out of regional powerhouse China, an important buyer of the commodities produced by Australia. The stampedes that result frequently leave traders crumpled up by the doors.

That’s the background; what’s more interesting is that within the downtrend on the daily chart, AUD has pulled back to a level that Todd’s methodology identifies as a potential short trade entry, in the neighborhood of 1.0470.  In addition, there appears to be potentially strong resistance at the 1.0630/35 level (1.5% away) which would offer an opportunity to sell more, and provide a logical stop if the trade refused to behave properly. The minimum profit objective would be 50% of the distance between the entry level to the recent low, or 1.0470 – (1.0470 – .9928/2), or 1.0199. Let’s call it 1.02. That would represent a minimum objective of 270 points (.0270), while a logical stop level would be above 1.0635, say 1.0655, 185  points (.0185) away. The trade thus has a better than 1/1 ratio of profit objective to stop; so far, so good.

A complicating factor in foreign exchange is in interest rate differentials. Traders who are long AUD have to roll their positions forward, and as mentioned previously, since the annual interest rate differential between Australia and the U.S. is roughly 3.50%, the position will cost slightly more than  1 point (.0001 ) every day the position is held.  The basic principle is that forward rates will adjust until the buyer and seller of AUD and USD are indifferent as to which currency they are holding, which at present works out to 375 points (.0375) a year.

The economic background, and the interest rate differentials, are something to be aware of in deciding how much potential profit is required to enter the trade; once that decision is made, the analytical tools taught by Todd can be used to select entries, profit objectives, and stops. A look at the hourly chart suggests that in this timeframe, the currency is ever so reluctantly trending higher, so if the decision is made to open a position around the 1.0470 level, it might be worthwhile to wait for a push below the support in this time frame at 1.0455, which has occurred as I type.

Hopefully, this helps to provide an overview of some of the factors that go into identifying a potential FX trade, and the use of some of the tools that Todd offers his students in  managing positions. So far, this looks like it might well work; the currency is currently trading at 1.0437, after falling to 1.0430. If it now bounces back to what had been support on the hourly  around 1.0455, and that level holds, confidence that this is a good trade at the right level will be even higher. It is a volatile currency, however, so if it is to be added to, and then stopped above logical resistance, those levels should always be in place as orders. I know from experience how difficult it is to make a decision upon being awakened from a sound sleep by a colleague with a surprising piece of economic news. Best to leave the levels, secure in the knowledge that they’ve been selected objectively.

Gold Downdate

Well, things change; despite some bids underneath by reserve managers (aka, central banks), we’re seeing pretty sizable liquidation of spot gold holdings by hedge funds, and the buying interest is being overwhelmed.

I continue to see something around 175 in the GLD ETF as a reasonable place to begin building a long position, but given the intensity of the selling, I would be content to watch it rather than just stick a bid in and wait to get smacked.  I might be really thirsty, but still have no interest in getting in front of a tsunami.

Waiting for Bernanke

An article in the Washington Post suggesting that Fed Chair Bernanke is unlikely to promote any significant new initiatives in his Jackson Hole speech on Friday is generating some comment in the FX market, and negative vibes in equities.

The durable goods report for July, which was just released, came in much higher than expectations at +4%, and +0.7% ex-transportation. Some elements of the report were less robust, but on balance it should be encouraging for longs.

The French bank SocGen, which has a sizable hedge fund practice, estimates that hedge funds are net short 71,000 S&P futures contracts.  Many of those are no doubt hedges against other longs, but it does suggest that if there is is a positive catalyst, short covering alone could give stocks a nice pop higher.

In FX, the Japanese set up a $100 billion fund that’s basically designed to compensate for the effects of a very strong Yen. Participants in the FX market are assuming that this means that they’ve given up on the idea of using intervention to try to force the Yen lower. Players are looking for a quick retest of 75.95, as long as someone else goes first. I would expect a lot of piling on should that level be broken.

The other notable piece of business going through in FX this morning was the work of a couple of large and determined buyers of EUR/GBP, one an institution doing some portfolio rebalancing ahead of month end, the other a corporate name. The push higher in EUR/GBP propelled GBP/USD lower. The old joke about GBP is that it’s “an escalator up, an elevator down”, and the truth of the saying was borne out this morning, as the move was quick and brutal.


Spot Gold has recovered some ground this morning, as the overall tone is definitely more cautious than yesterday’s “Risk on, Pal!”  I don’t think that there’s enough confidence to keep those who got long yesterday, and remained that way overnight, holding on if their profits start to erode. Best of luck today.

All Quiet on the Western (and Eastern) FX Fronts

Well, the Ministry of Finance evidently did not instruct the Bank of Japan to intervene to weaken the Yen last night, nor, apparently, has it done so thus far this evening. In the meantime, dealers took the Dollar up about a Yen from the recent low of 75.95; it is currently trading at 76.85. The Yen was given a nudge down last night when Finance Minister Koda warned that he was getting really, really, mad, and could act at any moment. Talk is certainly cheaper than intervention, as long as it gets the job done, and thus far shorter term players seem content to sell Yen, since that’s working. In addition, there’s now some political uncertainty, since Prime Minister Kan has announced that he is stepping down – which was widely anticipated – and that a new Prime Minister will be chosen on August 30. Japanese stocks, led by exporters, are up about 1 per cent in the early going.

I have to admit that after a couple of weeks of fun and games, today was beyond boring. We saw some flows in the morning, with reserve managers – central banks and sovereign wealth funds – buying reasonable amounts of Australian and Canadian Dollars, and, more unusually, Sterling. By the time the London fixing rolled around at 11 EDT, the day was pretty much done, and only the metals desk sounded lively. Since the big event of the week is Fed Chair Bernanke’s speech at the Kansas City Fed’s annual gathering at Jackson Hole, and that doesn’t occur until Friday, this has the potential to be a long week. Plenty of people are on vacation, and August is traditionally on the slow side, so perhaps my complaints are misplaced. Today would have been a terrific day for golf.

Will the Bank of Japan Intervene Tonight?

It’s Sunday evening in the U.S., which means that it’s Monday morning in the Far East, with currency traders already hard at work. There has been a good deal of speculation that the Japanese authorities will intervene to drive the Yen lower. A Yen at the current level, around 77 per Dollar, makes Japanese goods very expensive overseas, which in turn reduces exports, hurts the earnings of exporters, and slows the economy.  Taking a look at a 5-year chart brings home the scope of the problem; in 2007, the USD/JPY rate was close to 125, meaning that the Yen is roughly 38% stronger now. That’s a pretty strong headwind for an export-oriented economy to face, and it becomes stronger with every additional increase in the value of the Yen.

It might be worth taking a minute to discuss the mechanics of central bank intervention. In the case of Japan, the Ministry of Finance, which is roughly analogous to the U.S. Department of the Treasury, instructs the Bank of Japan, which in the U.S context would be the Federal Reserve Bank of New York, to intervene. The BoJ’s traders have several options; they can leave orders to buy Dollars and sell Yen with local banks (many traders believe they were already doing this last week), they can place orders on the electronic dealing machines (Reuters and EBS are the largest), or they can call banks directly, ask for prices, and buy Dollars. They’re capable of dealing in enormous amounts; billions, perhaps tens of billions, of Dollars. They can also ask other central banks, including the New York Fed, to intervene in their own time zones. In general, non-Japanese finance ministries and central banks, not convinced of the utility of intervention, have been reluctant to do so.

The last time I was on a trading desk when the New York Fed came in on behalf of the Bank of Japan, the trader at the Fed made it very clear that this was done to accommodate a central bank peer, and did not represent the policy of the U.S. authorities. In fact, it was so early (6:45 AM or so in New York) that the local market was barely awake. When my trader made an ill-informed price that would have resulted in a certain loss, the Fed trader, instead of dealing, simply asked him to refresh the quote, and then dealt at a price that was much better for my shop, and by the same token, worse for the Bank of Japan.

A peculiarity of the Ministry of Finance is that it prefers to intervene when the market is largely complacent and positioned poorly. Because the noise level was so loud over the weekend, it’s hard to believe that any professional trader will be caught by surprise if there is intervention in tonight’s session. This may be enough to convince the Japanese authorities to postpone an assault, in the hope that they can get more bang for their Yen in the future. Their track record has been mixed, and over the long run, as the 5-year chart indicates, they haven’t been successful in doing more than giving traders better opportunities, on occasion, to short USD/JPY.

We did break the 76.25 level on Friday; this was supposedly the “line in the sand” that would provoke an all-out attack by the MOF and the BoJ. Although plenty of stop losses got done on the break – the Dollar got as low as 75.95 – it rebounded pretty quickly, and my sense is that many short term traders are now long Dollars, hoping to take advantage of intervention to sell higher, and then perhaps sell Dollars again from the improved levels. Should the previous low break, I would expect plenty of Dollars to get sold again, but at the moment, we’re almost a Yen higher, at 76.86.

For those involved, or considering getting involved, best of luck, but be careful; when intervention is happening on a large scale, stops can get done some distance from where the orders are left.

The Swiss Miss, and the FX Market Swings

This is my first effort at providing my fellow students at TradingConcepts with updated information, views and impressions from (primarily) the foreign exchange market, where I spend my working days. I’ve learned a tremendous amount from Todd Mitchell, and it has helped me to navigate charts in a variety of time frames, and to structure trades based on my reading of those charts. At the same time, the FX market generally trades in reasonably well-established ranges that broadly reflect what is discounted, or “priced in” at any given point in time. Players in the FX market normally discount new information immediately, and on occasion their sense of fundamentals will change enough to create a new range, which of course involves violating previous resistance or support. This in turn generally leads to widespread triggering of stop loss orders, and a spike in volume and price. While a new range will become quickly inscribed in the charts, it can be helpful to be aware of what other market participants are talking about, anticipating, and fearing, so that the potentially negative effects of being caught in as a range changes can be mitigated,  if not always completely avoided.

With that said, we had one potentially range-altering item on the docket today, and it proved to be largely a dud. On Tuesday, the market was abuzz with very specific talk that the Swiss National Bank was about to peg the Swiss Franc to the Euro at a rate of 1.2025. This at first seemed unlikely, since the existence of a peg would obligate the SNB to intervene as needed to defend it, potentially adding to its already huge and hugely unprofitable EUR reserves. Still,  from a low of 1.1165 the EUR/CHF cross ran up to 1.14 and change. The cantonal (regional) banks, politically well plugged in and normally well informed, were seen buying aggressively on the move higher, as were a number of hedge funds. The presence of these typically astute  EUR/CHF buyers gave some credence to the rumors.

In point of fact, the Bank did act aggressively in the forward FX markets, dealing in 3-month swaps at levels that pushed Swiss money market rates below zero. The Bank also promised to continue providing more than ample liquidity. The Economics and Finance ministers appeared at a press conference at which they pledged the government’s full support to whatever measures were deemed necessary by the SNB. Given the difficulties faced by the Swiss export sector as a result of the use of CHF as a safe haven currency, there is no doubt strong support within the country for a weaker currency.  The SNB did at times in the past have some success in reversing a strong upward trend in Swiss by imposing negative interest rates, but that was during periods when money market interest rates were generally high in the developed world. There was thus a real cost attached to holding Swiss as opposed to, say, Eurodollars yielding north of 10%.

In the current low interest rate environment, the opportunity costs are much less, and investors’ desire for safety is such that a small degree of negative carry may seem a cheap price to pay for a degree of security. Even the Yen, which in terms of real return offers a negative interest rate, is a prominent haven at present, as is Gold, which of course pays no interest at all. Under the circumstances, the SNB appears to have its work cut out for it. There was some disappointment at the lack of a peg, and the cross came off a high of 1.1555 roughly two big figures, to 1.1349. Still, the market as a whole appears willing to see if the intervention in the forwards, and possibly additional steps, are successful in the short term. Given the strength of the move in the European afternoon on Tuesday, I would have expected even a stronger corrective move today.When FX profits in crowded trades begin to erode, those who are slow to take them often have few left to take. We’ll see how it goes overnight.

In the course of the day, my desk did see central bank reserve managers buying SEK and NOK, which might have been expected, but also GBP, MXN, and BRL, which are more aggressive choices. One theme this year has been the drive by central banks and sovereign wealth funds to diversify their reserves away from Dollars and, to a lesser degree (since they don’t own as many) Euros. The Canadian Dollar is also a beneficiary of this reserve diversification, but the close ties of the Canadian economy to that of the U.S. tend to make potential buyers cautious when the USD is under pressure. On those days, USD/CAD weakens, but CAD underperforms on the major crosses.

In any case, I’ll make an effort, as noted at the outset, to offer my take on what interbank dealers and institutional investors are fretting about and contemplating as reasons to alter their holdings. The trend is our friend until it’s broken; I’ll try to provide some early warnings as to what might provoke the sort of move that makes for funny chart patterns. The decisions made by the major market players will be reflected in due course in the charts, and when trends are developing, they can be traded very profitably by using the methodology taught by Todd.  Hopefully, this blog will help to preserve capital from time to time, when the market’s attention, and ranges, are shifting.


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