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Archive for September, 2010

Bullish on the Euro?

Sep. 29th 2010

Wouldn’t life just be a little easier if the EUR/USD, the most important forex pair and bellwether of currency markets, could simply pick a direction and stick to it. It dove during the financial crisis, only to surge during the apparent recovery phase, fell during the sovereign debt crisis, and rose during the paradigm shift, then fell as risk appetite waned, only to rise again in September, en route to a 5-month high.

Euro Dollar 5 Year Chart 2006-2010
There are a handful of factors which currently underlie the Euro’s strength, which can all generally be explained by the fact that risk is “on” at the moment, and the markets are moving away from so-called safe haven currencies and back towards growth investments. Of course that could change tomorrow (or even 5 minutes from now!), but at the moment, risk appetite is high and the Euro symbolizes risk. Never mind how ironic it is, that growth in the EU is projected at 1.8% for the year while Rest of World (ROW) GDP will probably top 5%. All that matters is compared to the Dollar (and Yen, Pound, Franc to a lesser extent) the Euro is perceived as the currency of risk.

The Euro’s cause is also helped by the ongoing “currency wars,” which heated up last week with Japan’s entry into the game. Basically, Central Banks around the world are now competing with each other to devalue their currencies. In contrast, the European Central Bank (ECB) has decided to remain on the sidelines (in favor of fiscal austerity), which is forcing the Euro up (or rather all other currencies down). To make matters even worse, “The U.S. Federal Reserve indicated this summer that it may ease monetary policy further… often seen as printing money to pump up the economy.” As a result, “The euro looks set to keep on climbing in a trend that looks increasingly entrenched.”

There are certainly those that argue that the Euro’s recent surge reflects renewed confidence in the Eurozone economy and prospects for resolving the EU debt crisis. After all, most Euro members will reduce their budget deficits in 2010 and auctions of new bonds are once again oversubscribed. On the other hand, interest rates for the PIGS (Portugal, Italy, Greece, and Spain) have risen to multi-year highs, as investors are finally trying to make a serious effort at pricing the possibility of default.

Eurozone sovereign debt interest rates graph 2007-2010
In addition, the credit markets in the EU are barely functioning, and large institutions remain dependent on the ECB’s credit facilities for financing. Finally, it shouldn’t be forgotten that the only reason crisis was due to the massive support (€140 Billion) extended to Greece. When this program expires in less than three years, the fiscal problems of Greece (and the other PIGS) will be exposed once again, and a new (stopgap) solution will need to be proposed.

As every analyst has pointed out, none of the EU’s fiscal problems have been solved. EU members have certainly proven adept at resolving acute crises and the ECB certainly deserves credit for keeping credit markets functioning, but none has proposed a viable solution for repairing of member countries’ fiscal and economic health. Currency devaluation is impossible. Sovereign default is being prevented. That leaves wage cuts and increased productivity as the only two paths to equilibrium. The former could be accomplished through inflation, but the ECB seems reluctant to allow this to happen.

Eurozone Budget Deficits, GDP

For better or worse, the EU seems to have pushed these problems down the road, and if all goes according to plan, they won’t need to be revisited for 2-3 years. For now, then, the Euro is probably safe, and may even thrive. Short positions in the Euro are being unwound with furious speed and data indicate that there is still plenty of scope for further unwinding. Inflation remains subdued, economic growth is stable, and the ECB so far hasn’t voiced any disapproval of the Euro’s rise. While I promote this bullishness with the caveat that “traders have shown a willingness to smack the euro lower from time to time on the slightest news or rumor of downgrades to euro-zone sovereign or bank ratings,” the general Euro trend is now unquestionably UP.

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Posted by Adam Kritzer | in Central Banks, Euro, News | 2 Comments »

RMB Appreciation Accelerates, but Dollar Peg Remains in Place

Sep. 27th 2010

The Chinese Yuan has touched a new high, at 6.69 USD/CNY. Given that the Yuan has still only risen about 2% since the peg was officially loosened in June –  with most of that appreciation taking place in the last couple weeks – there still remains intense pressure on China to do more.

Last week’s intervention by the Bank of Japan diverted a tremendous amount of attention towards the Yuan. In fact, many analysts have argued that it is only because of the Yuan-Dollar peg (itself, as well as the Chinese purchases of Yen assets that it engendered) that Japan was forced to act: ” ‘Countries see that getting involved in currency manipulation is a way to give themselves an advantage’…’China, their actions affected Japan, and Japan is affecting us.’ ” The Yen intervention could also force the G20 to re-focus its attention on the Yuan, and at least devote some discussion to it at the next summit.

CNY USD 1 Year Chart 2010

It should be noted that the two soundbites above both emanated from US Congressmen, which is important because the US government is currently mulling action on the Yuan currency peg. Politicians are growing tired by the Treasury Department’s repeated failure to call China a “Currency Manipulator,” which would require diplomatic talks and even trade sanctions. The Treasury will have an opportunity redeem itself in its next report on foreign exchange, due out on October 15, but it is expected that the report will either be delayed or released without adequately addressing the undervalued Yuan.

In fact, Treasury Secretary Geithner testified before Congress last week, and at least admitted that something needed to be done: “The pace of appreciation has been too slow and the extent of appreciation too limited. We have to figure out ways to change behavior.” However, this was only in response to acerbic criticism – (Senator Schumer told him, “I’m increasingly coming to the view that the only person in this room who believes China is not manipulating its currency is you.”) – and he ultimately failed to outline a timetable/blueprint for action. Despite the consensus among politicians (and President Obama) that the currency peg is harmful to the US economy, Geithner made it clear that the Treasury Department continues to favor unilateral action towards dealing with problem, without Congressional intervention. For now, then, politicians are probably relegated to saber-rattling and name-calling.

China’s response to this charade has been predictable. Trade representatives hinted that China wouldn’t bow to external pressure, and that any attempt at “punishment” would be met with countervailing actions. China also questioned the economics between arguments that the Dollar peg contributes to trade imbalance, calling such claims “groundless.” This position is actually supported by the notion that while the Yuan appreciated by 20% against the Dollar from 2005-2008, the US/China trade deficit actually widened.

In practice, China is likely to stick to its policy of gradual Yuan appreciation, or a few reasons. First of all, while Chinese policymakers know that they don’t need to wholly appease US politicians, they at least need to pretend that they are listening. It’s true that the US is dependent on Chinese products and its purchases of Treasury Bonds. However, it is arguably just as dependent on the US to buy its exports, which promotes employment and social stability, and it is keen to avoid a trade war if possible.

Second, a long-term appreciation of the RMB is actually in China’s best interest. If it wants to spur domestic consumption and promote more value-added manufacturing, it will need a more valuable currency. Outbound M&A, especially involving natural resource companies, will also be more economical if the Yuan is worth more. Also, if China has any serious ambitions of turning the Yuan into a global reserve currency, it will need to create capital markets that are deeper and more liquid, which it is currently unmotivated to do, lest it spur demand for Yuan by foreign institutional investors.

Finally, China should let the Yuan appreciate because it is financially gainful to do so. As I mentioned above, its trade surplus with the US has widened over the last few years as prices for its exports grow along with quantity. Meanwhile, prices for imports and prices paid for commodities and other natural resources have declined in Yuan-terms. For that reason, I think China will probably continue to stick its current policy, and allow the RMB to continue to slowly inch up.

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Posted by Adam Kritzer | in Chinese Yuan (RMB), News, Politics & Policy | No Comments »

Thai Baht Rises to 13-Year High

Sep. 24th 2010

As I pack my bags and head to Thailand for a vacation (for forex research purposes…yeah right), I thought it would be appropriate to blog about the Thai Baht’s strength. The momentum behind the Baht has been nothing short of incredible, and as often happens in the forex markets, the currency’s rise is becoming self-fulfilling. It has already appreciated 8.5% over the last year en route to a 13-year high, and some analysts predict that this is just the beginning.

THB USD Baht Dollar Chart 2006-2010

The last time I travelled to Thailand, in 2004, the Baht was trading around 40 USD/THB, compared to the current exchange rate of 30.7. That’s pretty incredible when you consider that during the intervening time, Thailand experienced a military coup and related political instability, as well as a financial crisis that dealt an especially heavy blow to the world’s emerging market currencies. And yet, if you chart the Baht’s performance against the Dollar, you would have only the faintest ideas that either of these crises took place.

To be sure, the financial crisis exacted a heavy toll on Thai financial markets and the Thai economy. Stock and bond prices lurched downward, as foreign investors moved cash into so-called safe haven currencies, such as the US Dollar and Japanese Yen. However, the Thai economy was among the first to emerge from recession, expanding in 2009, and surging in 2010. “Compared with a year earlier, GDP rose 9.1%, while the economy grew 10.6% in the first half,” according to the most recent data.  Tourism, one of the country’s pillar industries, has already recovered, along with exports and consumption. Projected export growth of 27% is expected to drive the economy forward at 7-7.5% in 2010, according to both the IMF and Thai government projections. The consensus is that growth would have been even more spectacular (perhaps 1-2% higher) if not for the politcal protests, which were finally quelled in May of this year.

Thailand GDP 2008-2010

Despite concerns about risk and volatility, foreign investors are once again pouring funds in Thailand at a record pace. Over $1.4 Billion has been pumped into the stock market alone in the year-to-date. As a result, “Thailand’s benchmark SET Index has rebounded30 percent since May…helping send the SET to its highest level since November 1996.” Capital inflows are also being spurred by Thai interest rates, which are rising (the benchmark is currently at 1.75%), even while rates in the industrialized world remain flat.  At this point, the cash coming into Thailand well exceeds the cash going out, which remains low due to steady imports and restrictions on capital outflows by Thai individuals and institutions. This imbalance is reflected in the Central Bank of Thailand’s forex reserves, which recently topped $150 Billion, more than 50% of GDP.

Anticipation is building that Thailand will use some its reserves to try to halt, or even reverse the appreciation of the Baht. After last week’s intervention by the Bank of Japan, such intervention is now seen not only as being more acceptable, but also more necessary. Due to pressure from the Prime Minister, the Central Bank has convened at least one emergency meeting to determine the best course of action. So far, members can only agree that restrictions on capital flows and lending standards to exporters should be relaxed.

For what it’s worth, Thailand’s richest man has urged the Central Bank not to act: “The effort is likely fruitless as foreign capital is expected to incessantly flood into Thailand because of the country’s healthy economic recovery and export growth. The baht as a matter of fact should become even stronger should Thailand’s politics remain in normal condition.” He is supported by the facts, which show that the Thai export sector has held up just fine in the face of the rising Baht, though perhaps only because other Asian currencies have risen at a comparable pace.

If other Central Banks were to step up their intervention – (Deutsche Bank has argued, via the chart below, that all “Asian central banks have for many years been more or less persistently in the market “stabilizing” their currencies, but with a clear bias towards preventing USD depreciation in this region”) – the Bank of Thailand would probably have no choice but to follow suit.

Foreign Exchange Reserves, Central Bank Intervention in Asia 2000-2010

Otherwise, it might not be long before the Baht clears 30 USD/THB. My next post on the Baht, in 2015, will probably be in the form of a similar lamentation…

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Posted by Adam Kritzer | in Exotic Currencies, News | No Comments »

Interview with Marc Chandler: “You Win Through Discipline.”

Sep. 21st 2010

Today, we bring you an interview with Marc Chandler, the global head of currency strategy for Brown Brothers Harriman. Previously he was the chief currency strategist for HSBC Bank USA and Mellon Bank. Marc is a prolific writer and speaker whose essays have been published in the Financial Times, Barron’s, Euromoney, Corporate Finance, and Foreign Affairs. He is also the contributing economic editor for Active Trader Magazine and to TheStreet.Com. Below, he shares his thoughts on fundamental analysis versus technical analysis, the false Euro rally, Japanese Yen intervention, and other subjects.

Read the rest of this entry »

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Posted by Adam Kritzer | in Interviews, News | 2 Comments »

Keep an Eye on Central Banks

Sep. 20th 2010

From monetary policy to quantitative easing to forex intervention, the world’s Central Banks are quite busy at the moment. Even though the worst of the credit crisis has past and the global economy has moved cautiously into recovery mode, there is still work to be done. Unemployment remains stubbornly high, inflation is too low, and asset prices are teetering on the edge of decline. In short, Central Banks will continue to hog the spotlight.

On the monetary policy front, Central Banks have begun to divide into two camps. One camp, consisting of the Federal Reserve Bank, European Central Bank, Bank of England, Bank of Japan, and Swiss National Bank (whose currencies, it should be noted, account for the majority of foreign exchange activity), remains frozen in place. Interest rates in all five countries/regions remain at rock bottom, near 0% in most cases. While the ECB’s benchmark interest rate is seemingly set higher than the others, its actual overnight rate is also close to 0%. Meanwhile, none of these Banks has given any indication that it will hike rates before the end of 2011.

In the other camp are the Banks of Canada, Australia, Brazil, and a handful of other emerging market Central Banks, all of which have cautiously moved to hike rates on the basis of economic recovery. Among industrialized countries, Australia (4.5%) is now at the head of the pack, with New Zealand (3%) in a distant second. Brazil’s benchmark Selic rate, at 10.75%, makes it the world leader among (widely-followed) emerging market countries. It is followed by Russia (7.75%), Turkey (7%), and India (6.1%), among others. The lone exception appears to be China, which maintains artificially low rates to influence the Yuan. [More on that below.]

None of the industrialized Central Banks have yet unwound their quantitative easing programs, unveiled at the peak of the credit crisis. The Fed’s balance sheet currently exceeds $2 Trillion; its asset-purchase program has driven Treasury rates and mortgage rates to record lows. The same goes for the Banks of England and Japan, the latter of which has actually moved to expand its program in a bid to hold down the Yen. Meanwhile, many of the credit lines that the ECB extended to beleaguered banks and other businesses remain outstanding, and have even expanded in recent months.

Central Bank Credit Crisis Intervention 2007-2008

Central Banks have been especially busy in the currency markets. The Swiss National Bank (SNB) was the first to intervene, and as a result of spending €200 Billion, it managed to hold the Franc below €1.50. As a result of the EU sovereign debt crisis, however, the Franc broke through the peg and his since risen to a record high against the Euro. Unsurprisingly, the SNB has abandoned its forex intervention program. Throughout the past year, the Central Banks of Canada, Brazil, Thailand, Korea have threatened to intervene, but only Brazil has taken action so far, in the form of a levy on all foreign capital inflows. Last week, the Bank of Japan broke its 6-year period of inaction by intervening on behalf of the Yen, which instantly rose 3% on the move. The BOJ has pledge to remain involved, but the extent and duration is not clear.

Finally, the Bank of China allowed the Yuan to appreciate for the first time in two years, but its pace has been carefully controlled, to say the least. In the last few weeks, the Yuan has actually picked up speed, but critics insist that it remains undervalued. In addition, China has contradicted the Yuan’s rise against the Dollar through its purchases of Japanese bonds, which has spurred a rise in the Yen. This is both ironic and counter-productive to global economic recovery: “Since China is growing at 10%, it can afford to undermine exports and boost domestic demand by letting the yuan appreciate more rapidly against the dollar. But China doesn’t want to do that. In fact, although China’s State Administration of Foreign Exchange deregulated the currency market overnight, the measures, which allow some exporters to retain their foreign currency holdings for a year, should boost private demand for dollars, not yuan.”

The efforts listed above have undoubtedly moderated the impacts of the financial crisis and consequent economic downturn. However, the banks have found it impossible to engineer a convincing recovery, and at this point, there probably isn’t much more that they do can do. As a result, many analysts are now pinning their hopes on fiscal policy (despite its equally dubious track record). Perhaps, the title of this post should have been: Keep an Eye on Governments and their Stimulus Plans.

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Posted by Adam Kritzer | in Central Banks, News | 1 Comment »

Hungarian Forint Touches Record Low

Sep. 19th 2010

Anyone who had bought emerging market currency(s) at the peak of the credit crisis in 2008 would have earned double digit annualized returns in the two years that have passed since then. There are only a handful of exceptions to this rule, and the most prominent one that I can think of is the Hungarian Forint. If you had bought the Hungarian Forint against the Swiss Franc (the base currency that most traders in the Forint look at, for reasons that I will explain below) in the fall of 2008, you would incur a loss of a 63% if you sold today. The Forint is down 11% in the last month alone. These are the kinds of numbers one might associates with mortgage-backed securities and credit default swaps, not currencies!

Swiss Franc CHF Hungarian Forint HUF 2010

So why is the Forint in the doghouse? Ironically, the answer is connected to mortgages. During the inflation of the housing bubble, Hungarians preferred to borrow in Swiss Francs, because interest rates were significantly lower than domestic Hungarian rates. This was not a mere trend; it was a full-blown phenomenon: “About 5.4 trillion forint($24.1 billion), or two-thirds of Hungary’s overall household credit, is denominated in foreign currencies. Of that, 82 percent is in Swiss francs, according to central bank data.” When the housing and credit markets were stable, noone bothered to examine currency risk. Given how much the Forint has fallen against the Franc, you can bet they are now.

As if the decline in housing prices wasn’t bad enough, consider that Hungarians that borrowed in Swiss Francs have now seen their mortgage payments/balances increase by more than 50%, depending on when they took out their loans. It goes without saying that even under the best of circumstances, it would be difficult to find the wherewithal – let alone the motivation – to repay such a loan. When you throw an economic recession into the mix, the prospects for repayment become even more bleak. As the Hungarian Forint has depreciated, loan defaults have risen, further stoking the Forint’s depreciation and loan defaults.

Alas, the Hungarian government’s program for solving this crisis is to punish the banks, both by allowing borrowers to delay repayment and by levying a massive tax – the highest on the EU – on all banks. While this might be helpful for bringing down the country’s budget deficit to the 3% mandated by the EU, it probably won’t do much for the economy. Speaking of the budget deficit, it has prompted S&P to warn of a possible cut in Hungary’s sovereign credit rating to junk-status.

Hungary’s cause hasn’t been helped by the breakdown of talks with the EU and IMF that would have supplied it with emergency funding. As if it wasn’t obvious from the Forint’s decline, investors are beginning to fear the worst and are slowly turning away from Hungary. The country’s benchmark stock market index has fallen 4% over the last six months. Meanwhile, foreign lenders are starting to balk at buying Hungarian debt without some kind of EU/IMF backstop, much like the one that was afforded to Greece: “Auction saleshave been a barometer of investor confidence in the country. On Sept. 2, Hungary sold 35 billion forint of 12-month Treasury bills, 15 billion forint less than planned, after receiving bids for 63.4 billion forint of the bills. Five days later, it sold 60 billion forint of three-month Treasury bills, 10 billion forint more than planned.”

At this point, all eyes are on the Hungarian government to simultaneously boost the economy and repair its budget deficit: “The rating agenciesare taking the same line as the markets and giving the government until local elections in October the benefit of the doubt, but if they don’t see then either a recommitment to the IMF program, or real concrete measures I think they move to cut the rating to junk.” If that were to happen, the self-fulfilling downward spiral in the Forint would probably continue unabated.

It makes you wonder: if the Greek Drachma were still around, how closely would it resemble the Forint?

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Posted by Adam Kritzer | in Emerging Currencies, News | 3 Comments »

Japan Finally Intervenes in Forex Markets

Sep. 15th 2010

After months of speculation, the Bank of Japan (BOJ) has finally intervened in the currency markets. As the plummeted towards a fresh low against the Dollar, the BOJ swiftly entered the market, driving the Yen up 2% instantly. On the day, it finished 3% higher against the Dollar.

Over the last few weeks, Japan had been inching slowly towards intervention. [In fact, I was prepared to write a post yesterday about intervention being imminent, but that is neither here nor there…] The Finance Minister, Governors of the Central Bank, Members of Parliament, and even the Prime Minister himself had started to become increasingly vocal about the Yen’s un-halting rise, and the need to control it. It had already touched a 15-year high, and was only 4% away from it’s all-time low. With rhetorical intervention and its easy monetary policy failing to sway investors, the Bank of Japan sold an estimated $20 Billion worth of Yen on the open market.

BOJ Japanese Yen Intervention September 2010 

By no coincidence, the intervention was carried out only one day after a Parliamentary vote to see whether Naoto Kan would be replaced as Prime Minister. Having defeated Ichiro Ozawa and survived the challenge, Kan evidently was determined to make good on his promise to rescue the economy from the brink of another downturn. (Only a few days earlier, he admitted, “We’re conducting various talks, so other countries won’t say negative things when Japan acts. We’re studying now various scenarios, examining possible responses from markets when we take a decisive measure.”)

Reaction to the intervention has been mixed. On the one hand, the fact that the BOJ waited so long before stepping in is evidence that this measure was taken out of desperation. According to Billionaire investor George Soros, “Japan was right to act to bring down the value of the yen. ‘Certainly, they are hurting because the currency is too strong so I think they are right to intervene.’ ” Politicians and policymakers, on the other hand, were not so kind. One US Senator called the move “disturbing” and Jeane-Claude Trichet, President of the ECB, said it was “not…appropriate.”

From these snippets, then, it’s clear that the intervention is being conducted unilaterally and lacks any support from other Central Banks. Thus, if the BOJ is to continue selling the Yen, it will do so alone and perhaps even under the open contempt of other Central Banks. At the same time, it appears to have some credibility with investors, who may back off the Yen for the time being. That’s because the BOJ is trying to make owning the Yen as unattractive as possible, by driving down interest rates and attempting to spur inflation. Whether investors will take the hint and stop and return to using the Yen as a funding currency for the carry trade is still unclear. (Despite unraveling significantly over the last two years, the Yen carry trade may still exceed $500 Billion). Japan also has to contend with China, which has been putting upward pressure on the Yen by buying Japanese bonds.

For that matter, it’s not even clear whether the BOJ will continue to intervene. Perhaps it just wanted to send a message to investors by showing that it can weaken the Yen any time it wants. Besides, a protracted campaign to hold down the Yen would be expensive and doomed to failure over the long-term, as the BOJ learned the hard way in 2003-2004 and has probably been reminded of by the Swiss National Bank’s recent failure to weaken the Franc. On the other hand, the BOJ needs to show investors that it is serious, and a “shock and awe” intervention campaign is probably the only real way to achieve this.

Either way, I think it’s fair to say that those who bet on the Yen do so at their own peril. While I don’t think the Yen is suddenly going to return to 100 JPY/USD, the fact that my personal reserves are not nearly as vast as those of the Bank of Japan means I’m not inclined to bet on it…

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Posted by Adam Kritzer | in Japanese Yen, News | No Comments »

The Trend is Your Friend

Sep. 11th 2010

Raise your hand if you’ve ever heard that expression before? Well, now there’s proof that this well-worn phrase is more than just a pointless platitude: “Royal Bank of Scotland Group indexes that track the performance of four of the most popular currency strategies show that the so-called trend style was the best-performing method, returning 7.3 percent this year through August.”

“Trend-Style” trading is also known as trend-following, and is just as it sounds. Traders identify one-way patterns in specific currency pair(s), and attempt to ride them for as long as possible. Given all of the big movements in currency markets this year, it’s no wonder that trend-following is the most popular. If you look at the 52 week trading ranges for the six most popular USD currency pairs, you can see that highs and lows are often as far as 20% apart. The EUR/USD pair, for example, fell 20% over a mere 7 months. Anyone who sold in December 2009 and bought to cover in June 2010 would have earned an annualized return of 35% without leverage! Even if you had captured only a couple months of depreciation would have yielded impressive returns. In addition, you could have traded the Euro back up from June until August and reaped a 60% annualized return. Best of all, both of these trends (down, then up) unfolded very smoothly, with only minor corrections along the way.

The Trend is Your Friend- USD/EURI’m sure serious technical analysts are rolling their eyes at the chart above, but the point stands that trend-following has never been easier and rarely more profitable than it is now. One fund manager summarized, “Trend-following investors are capturing the momentum in several big currency moves. You have so much uncertainty in the world now with regard to inflation or deflation, which typically makes currency markets and interest rates move. That is good for trend followers as it causes volatility, which typically creates good profits.” In other words, there is a tremendous amount happening in forex markets at the moment, and this is reflected in protracted, deep moves in currency pairs, which can change direction without notice and yet continue moving the opposite way for just as long. If you think this sounds obvious, look at historical data (5-10 years) for the majority of currency pairs: while trends have always been abundant, it was only recently that they began to last longer and became more pronounced.

The other three strategies surveyed by the Royal Scotland Group (“RSG”) were the Carry Trade, Value Trade, and Volatility Trade. Unfortunately, data was only offered for the carry trade strategy (confusingly referred to by RSG as the volatility strategy), which is down 5.9% in the year-to-date. The carry trade strategy involves selling a currency with a low yield and favor of one with a high yield, and profiting from the interest rate spread. In order for this strategy to be profitable, however, the long currency must either appreciate or remain constant. Thus, when volatility is high – as it has been over the last 2-3 years – this is a losing strategy.

We can only guess that a true volatility strategy probably would have been the second most profitable strategy. This strategy can be implemented through the use of long and short spot positions, as well as through trading in options and other derivatives. As I said, there is no shortage of volatility at the moment: “Since the collapse of Lehman Brothers in 2008, the dollar has seen record volatility against the euro…including six moves of at least 10%.” For traders that profit from volatility, the current uncertainty has created a windfall situation.

Volatility 2006-2010

However, it has made value trading – based on fundamentals and the notion of Purchasing Power Parity (PPP) – risky and unpopular: “The volatility also has made what would appear to be a straightforward bet against the dollar fraught with risk. Three factors tend to move currencies: the pace of growth, debt levels and interest rates. By those standards, the dollar should be falling against the currencies of emerging-market and commodity-producing nations.” Not only is this not the case (a decline in risk appetite has turned the Dollar into a safe-haven), but even betting on a protracted Dollar decline is itself risky because of surging volatility. One way around this is to trade a Dollar Index (by way of an ETF, for example) which is inherently less volatile (half as volatile, to be exact) than individual currency pairs.

That’s not to say that value trading isn’t profitable over the long-term. “Empirical evidence suggests that currencies…show a tendency to revert back toward PPP in the longer run.” Given current volatility/uncertainty, however, this strategy is unlikely to be profitable in the short run. Fortunately, uncertainty doesn’t negate opportunity, and traders should plot strategy accordingly.

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Posted by Adam Kritzer | in Investing & Trading, News | 2 Comments »

Swiss Franc Touches Record High, Nears Parity

Sep. 9th 2010

In the year-to-date, the Swiss Franc has risen 3% against the Dollar, 15% against the Euro, and more than 5% on a trade-weighted basis. It recently touched a record low against the Euro, and is closing in on parity with the USD. Since the beginning of the summer, the Franc has rallied by an unbelievable 15% against the Greenback. I don’t think I’m alone in scratching my head in bewilderment wondering, What could possibly be behind the Franc’s rise?


By this point, everyone is familiar with the safe-haven phenomenon. Basically, concerns of a double-dip recession have ignited a flare-up in risk aversion and spurred investors to shift capital into locales and investment vehicles that are perceived as less risky. Switzerland and by extension the Swiss Franc, have both benefited from this phenomenon: “Anxious investors searching for a haven from fears about the health of Europe’s banks, which knocked equities and sent peripheral eurozone government bond spreads higher, dumped the single currency. The Swiss franc benefited.” Enough said.

At the same time, the Dollar and Japanese Yen are also considered safe-haven currencies, and as you can see from the chart below, the three have hardly traded in lockstep. In other words, there must be something distinguishing the Franc. Economists point to a strong economy: “Gross domestic product rose 0.9 percent from the first quarter, when it increased 1 percent. ‘The underlying economics of Switzerland are very, very healthy. Concerns about deflation have subsided.’ ” The consensus is that the Swiss economy will expand by close to 2% on the year. However, this is hardly impressive, especially compared to other industrialized countries. In addition, Swiss interest rates remain low, which means the opportunity cost of holding the Franc is high. There must be something else going on.

In fact, it looks like the Swiss Franc’s rise is kind of self-fulfilling. For most of 2009, the Swiss National Bank (SNB) spent nearly $200 Billion to artificially hold down the value of the Franc. During this period, the Franc remained stable against the Euro and depreciated against the Dollar and Yen. Having finally broken through the “line in the sand” of €1.50, however, the Franc is now appreciating rapidly. Why? Because the SNB no longer has any credibility. It lost $15 Billion (due to the Euro depreciation) trying to defend the Franc, and in hindsight, the mission was a complete waste of time. As a result, a fresh round of intervention is out of the question. The currency markets have also dismissed the possibility of new intervention, and it seems they are punishing the SNB (via the Franc) for even trying.

According to analysts, the markets have also come to see the Franc as a reincarnation of the Deutschmark, due to its “strong economy, massive foreign reserves, traditional haven status and close links with the German economy.” Those that fear a Eurozone collapse and/or want to make exclusive bets on Germany are now using the Franc as a proxy. I don’t personally understand the logic behind this strategy, but where perception is reality, it’s more important to understand that other investors see the connection rather than seeing the connection for oneself.

Going forward, there is mixed sentiment surrounding the Franc. One analyst warned clients, “I would be cautious about chasing it too far in the short term. There’s still a huge number of headwinds out there.” According to another analyst, “We expect the franc to remain strong throughout the decade.” Personally, I’m inclined to side with the former point of view. From a fundamental standpoint, there isn’t a whole lot to keep the Franc moving up and its recent surge is probably running on fumes. At the very least, I would expect a correction in the near-term.

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Posted by Adam Kritzer | in News, Swiss Franc | No Comments »

CFTC Passes New Retail Forex Guidelines

Sep. 7th 2010

I have been covering the US Commodity Future Trading Commission’s (CFTC) efforts to revamp the regulatory structure that governs forex, since it was unveiled earlier this year. On August 30, the CFTC formally published the “final regulations concerning off-exchange retail foreign currency transactions. The rules implement provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act and the Food, Conservation, and Energy Act of 2008, which, together, provide the CFTC with broad authority to register and regulate entities wishing to serve as counterparties to, or to intermediate, retail foreign exchange (forex) transactions.”

Not only has the CFTC clearly established its authority to be the primary regulator of retail forex, but it has also laid out specific regulations. Chief among them is limiting leverage to 50:1 for major currency pairs, and 20:1 for “other retail forex transactions.” [It’s not presently clear which specific currency pairs will be classified as major].  Remember that the original proposal (which, along with my endorsement, generated vehement protest) called for a decline in leverage to 10:1. Due to negative feedback from traders and brokerages, which ascribed malicious political motives to the changes and argued that it would move the entire industry offshore, the CFTC backed down and implemented only a modest decline in leverage. However, it’s important to note that the National Futures Association (NFA) as well as individual brokers will have discretionary power in setting leverage limits lower than 50:1. There will undoubtedly still be some opposition from traders, but I think we can all agree that the new rule represents a fair compromise.

As for the claim that traders would/will move their accounts offshore, this will become largely moot, since all brokerages, regardless of nationality, will be required to register with the CFTC and subject to its rules/oversight. Of course, those traders that are so inclined will still find a way to circumvent the rules by shifting funds “illegally” to unregistered brokers, but they do so at their own risk and will have no recourse in the event of fraud. As Forbes noted, “It seems these new rules will put a stop to Americans trading retail forex offshore to evade CFTC rules. That trend picked up the pace in recent years and it may need to be reversed quickly.”

Brokerages must register as either futures commission merchants (FCMs) or retail foreign exchange dealers (RFEDs).  These institutions will be required to “maintain net capital of $20 million plus 5 percent of the amount, if any, by which liabilities to retail forex customers exceed $10 million.” While this rule will raise the barriers to entry for potential forex start-up brokerages, it will protect consumers against broker bankruptcy. In addition, “Persons who solicit orders, exercise discretionary trading authority or operate pools with respect to retail forex also will be required to register, either as introducing brokers, commodity trading advisors, commodity pool operators (as appropriate) or as associated persons of such entities.”

One final rule change worth noting is quite interesting: brokerages must “disclose on a quarterly basis the percentage of non-discretionary accounts that realized a profit and to keep and make available records of that calculation.” This calculation will be useful both in and of itself, and also in identifying any significant discrepancies between competing brokers. For the first time, we will be able to see whether forex trading is currently profitable (i.e. whether those that profit are in the majority or minority) and whether/how this profitability metric changes over time, in response to particular market conditions.

The new rules go into effect on October 18.

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Posted by Adam Kritzer | in Commentary, News | 4 Comments »

Australia Dollar Ebbs and Flows with Risk

Sep. 5th 2010

If you chart the course of the Australian Dollar over the last twelve months alongside the S&P 500, the overlap is jarring. You can see from the chart below that the two lines zig and zag in almost perfect unison. It would seem that there was a slight break in the second quarter of 2010, but even this is an illusion, since the Aussie and the S&P continued to rise and fall in the same patterns over that time period, differing only in degree of fluctuation.

Australian Dollar Versus S&P 500: 2009-2010
Since the S&P 500 is a pretty good proxy for risk it can be said that the Australian Dollar is a manifestation of investor risk appetite. When risk aversion was high, the S&P and the Aussie were low. When risk tolerance picked up, they rose. It’s funny how this came to be. It is probably best seen as a vestige from the credit crisis, whereby investors evenly divided assets into two classes: risky and safe. When you look at the performance of the Australian Dollar, it is pretty clear as to which side of the dividing line it was placed.

This is probably fair, since the Australian Dollar is a growth currency. According to the just-released Bank of International Settlements (BIS) Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity, the Australian Dollar is now the world’s fifth most traded currency (behind only the G4: Dollar, Euro, Yen, & Pound), having usurped that position from the Swiss Franc. In 2010, it accounted for 7.6% (out of a total of 200%) of all trading volume, primarily as a result of trading in the USD/AUD currency pair, which was the fourth most popular in forex.

Investors have come to see the Australian Dollar in somewhat contradictory terms. It is both stable and liquid, but its economy is unpredictable and inflation is usually above average. The current economic situation was strong, with GDP growth projected to exceed 3% in 2010. Its benchmark interest rate (4.5%) is the highest in the industrialized world, and may touch 5% before the year is over. On the other hand, its political situation is currently uncertain, thanks to an election that produced a hung Parliament and the recent resignation of its Prime Minster. In addition, while its trade balance is currently in surplus, it fell in July thanks to decreased demand from China. Analysts wonder whether it isn’t entirely dependent on China (directly via exports and indirectly via high commodity prices) to generate positive GDP growth.

Australia Balance of Trade - 2009- July 2010
Ultimately, investors don’t care about any of this. They care only whether the global economy is stable and whether another financial/credit/economic crisis is likely to occur. Even though any such crisis will probably spare Australia, the Aussie is punished by even the whiff of crisis because Australia is perceived as being riskier to invest than the US, for example. “The Australian dollar is going to stay heavy. Markets don’t like uncertainty,” summarized JP Morgan.

Sadly, it’s currently not worth parsing the nuances of trade statistics and monetary policy, because it has no bearing on the Aussie, though at least this makes my job easier. For the time being, the Australian Dollar will tick up if it looks like the global economy (principally the US) will avoid a double-dip recession. Otherwise, it is in for the same rough stretch as the S&P.

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Posted by Adam Kritzer | in Australian Dollar, Economic Indicators, News | 1 Comment »

Trading In Emerging/Exotic Currencies Increases

Sep. 2nd 2010

The long wait is over! The Bank of International Settlements (BIS) has just released the results from its Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity, conducted in April 2010. The report contains a veritable treasure trove of data, perhaps enough to keep analysts busy until the next report is released in 2013. [Chart below courtesy of WSJ].

Daily Turnover in Forex Markets

First, the data confirmed earlier reports that average daily forex volume had surged to a record level in 2010: “Global foreign exchange market turnover was 20% higher in April 2010 than in April 2007, with average daily turnover of $4.0 trillion compared to $3.3 trillion. The increase was driven by the 48% growth in turnover of spot transactions, which represent 37% of foreign exchange market turnover. The increase in turnover of other foreign exchange instruments [consisting mainly of swaps and accounting for the majority of forex trading activity] was more modest at 7%.” In addition, for the first time, investors and financial institutions accounted for a larger share of turnover than banks, whose trading activity has remained roughly unchanged since 2004.

The composition of the turnover actually didn’t change from 2007, interrupting a shift which had been taking place over the previous 10 years. Specifically, the share of overall turnover accounted for by the so-called major currencies actually increased in 2010, from 172% to 175%. [Since there are two currencies in every transaction, total volume sums to 200%]. Growth in the G4 currencies (Dollar, Euro, Pound, Yen) was more modest, however, increasing from 154% to 155%. This reversal is probably attributable to the credit crisis, which drove (and in fact, continues to drive) investors out of emerging market currencies and back into safe haven currencies, namely the Dollar, Yen, and Pound. However, this theory is belied by the significant increase in Euro trading activity, which certainly hasn’t benefited from the recent trend towards risk aversion.

Forex Composition, Major Currencies Versus Emerging Currencies

While emerging currencies as a group accounted for a smaller share of overall activity, certain individual currencies managed to increase their respective shares. The Singapore Dollar, Korean Won, New Turkish Lira, and Brazilian Real all fit into this category. Still other currencies, such as the Indonesian Rupiah and Malaysian Ringgit, also managed impressive gains but account for such a small share of volume as to be insignificant when looking at the overall the picture. Those who were expecting even bigger growth should remember that it’s ultimately a numbers game: the amount of Ringgit it outstanding is dwarfed by the number of Dollars, so any gains that the Ringgit can eke out are impressive. In addition, when you consider that the overall forex pie is also increasing, the nominal increase in volume for these small currencies was actually quite large.

Growth in Emerging Currencies Forex Volume
The ongoing search for yield in all corners of the financial markets is likely to bring some of the more obscure currencies into the fold. “In June, I began getting questions about Uruguay, Vietnam and others,” said Win Thin, senior currency strategist at Brown Brothers Harriman in New York…investors often asked Mr. Thin questions about less-familiar currencies such as the Ukrainian hryvnia and Romanian leu.” In the same article, however, Mr. Thin cautioned that interest in such currencies is still probably lower than in 2007-2008, for a good reason. “It’s not like the Group of 10, or even the more liquid emerging market currencies where, if you decide you’ve made a mistake, you can get out.”

Due to the lack of liquidity and higher spreads, these obscure currencies aren’t really suitable for trading. Of course there will be a handful of institutional and even retail investors that want to make long-term bets on these currencies. They tend to be more aware of the risk and less sensitive to the higher cost and lower convenience. The overwhelming majority of traders, however, churn their portfolios daily, if not hundreds of times per day. A 10pip spread on the USD/MXN (Dollar/Mexican Peso) would be considered too high, let alone a 50 pip spread on any transaction involving the Ukrainian hryvnia.

In short, the majors will account for the majority of trading volume for the foreseeable future, regardless of what happens to the Euro. At the same time, that won’t prevent a handful of selected emerging currencies, such as the Chinese Yuan, Indian Rupee, Brazilian Real, and Russian Ruble from increasing their share. As liquidity rises and spreads decline, volume will increase, and their rising importance will become self-fulfilling.

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