Rough Patch Ahead?

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By Mike Conlon | May 4, 2011

The data is starting to get a bit weaker and the market looks as though it is preparing for an economic “rough patch” that may be just around the corner. While we all know that QE2 will officially be coming to an end shortly, how long that lasts is anyone’s guess.

The first indicator of unemployment here in the US came out this morning, with the ADP jobs report showing gains that were les than expected. This comes ahead of tomorrow’s initial jobless which are expected in the low 400K range (which is higher than we had hoped when we reached the 300k range) and then Friday’s all-important Non Farm Payrolls report.

Overnight, the Central Bank of China issued hawkish statements that combating inflation was their number one concern, so the fear of a Chinese slowdown sent the MSCI Pac Rim stock index lower, taking commodities and commodity currencies lower as well.

Yet the Euro and the Pound are holding up well, as tomorrow’s rate policy decisions are expected to produce no change, yet the ECB policy statement could be hawkish. Retail sales figures in the Euro zone came in lower than expected, and home prices declined in the UK.

This all adds up to a global slowdown, which means that the market is convinced that Bernanke will attempt to come back to the rescue and put the training wheels back on the economy through further easing at the first sign of trouble.

In the forex market:

Aussie (AUD): The Aussie started the morning lower but has flipped to higher as the weak Dollar play is back in action.

Kiwi (NZD): The Kiwi is lower across the board as it is very much influenced by what goes on in the Chinese economy. Unemployment figures due out later tonight could put a positive spin on the NZ economy.

Loonie (CAD): The Loonie is mostly lower as oil prices have pulled back to a $110 handle and the dual problem of being so in bed with the US economy has further contributed to weakness. Nevertheless the weakening Dollar has just pushed the Loonie back toward .95 vs. USD. (Click chart to enlarge)

Euro (EUR): Greek debt restructuring. Declining retail sales figures (-1.7% vs. an expected no change). Portuguese and Irish debt costs ballooning. These might seem like major problems to any other currency that is not considered the “anti-Dollar”. The ECB rate decision will keep rates unchanged, but the statement could surprise. (Click chart to enlarge)

Pound (GBP): The Pound is also higher despite home prices that fell more than expected and the notion that the BOE will not change rate policy at tomorrow’s decision. Unlike the ECB, the BOE will not issue a policy statement.

Dollar (USD): The Dollar’s short-lived bounce from risk aversion has reversed and now we are looking at weakness as there is no confidence that a declining US economy will be allowed to function without the intervention of Bernanke and the Fed. The ADP employment change showed a gain of 179K jobs vs. an expectation of 195K.

Yen (JPY): The Yen is weaker as Japanese markets are closed today.

Well it looks like this is going to be a case of bad news is good news for stocks and commodities heading into the end of QE2. The worse the data gets, the higher the expectation that Bernanke will continue some sort of monetary easing.

Whispers of “QE2.5″ are making the rounds, and the artificial conditions that created thanks to this easy money policy are delaying the problem and not fixing it. While these delay tactics might be appropriate if we trying in earnest to get our fiscal act together, the politics of Washington are preventing certainty in the marketplace.

Questions about taxes, regulation, and government spending have not assuaged businesses, and the prevailing notion is that things are getting worse and not better.

To learn more about how you can take advantage of world events through the currency market, be sure to check out our currency trading courses!

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Euro Gains as ECB Readies Interest Rate Statement

The euro continued to make gains on the dollar this morning rising 0.5 percent to $1.4901 at 8:30 an in New York. Investors are hopping aboard the euro as speculation grows that tomorrow’s statement from the European Central Bank will strongly hint at further interest rate increases for the Eurozone.

“The ECB has nailed its anti-inflation colors firmly to the mast, and the Fed hasn’t even got around to starting yet,” said Steven Barrow, a currency strategist at Standard Bank Plc in London. “This euro rally won’t extend too far if the ECB isn’t as hawkish as the market expects.”

Source: Bloomberg

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Interview with InnerFX: “JPY and CHF will Continue to Strengthen”

Today, I bring you an interview with Liviu Flesar, an independent trader and blogger. His portal is InnerFX, which is billed as a “useful resource for traders from all over the world and a trading blog where novice traders can learn how to trade better.” Below, Mr. Flesar discusses his background and shares his thoughts on the major currencies, setting up trades, and how to reform the rating agency system.

Forex Blog: I’d like to begin by asking you about your background as a trader and as a commentator. How did you get started in forex? At what point did you make the transition from trading currencies to offering analysis to the public? What was your motivation for that decision?

Hello Adam, thank you for inviting me to the interview. Back in the year 2003, some friends were talking about investing in the stock market. I had listened to their conversations, which was quite interesting, even though I had only a little idea about what they meant. Once I got back home, I started to search on the Internet â€" looking for Stock Investing websites to learn more about it. I stumbled across various sites and soon opened my first account on a gambling site. Gambling â€" that’s right. For example, it was possible to try predicting the last decimal of a financial instrument after 10 market ticks. That was crazy and foolish. I blew my account after two weeks, so I decided to take a break and do some more research.

After browsing though forums and trading sites, I discovered the exciting and challenging world of FX Spot Trading. I also signed up with a trading advisory service, expecting to replicate its performance. The advisory service went out of business after almost one year, and I felt like I was alone in a dark place. Retail FX wasn’t too popular 7 years ago and there were only a few FX sites, so it was quite hard to find another reliable advisory service. While searching and trying to learn more, I came to understand that it’s best if I use my own brain to trade, as it is almost impossible to be successful on the long run by following other people.

I started to share my analysis with the public after one year, in 2004. I wasn’t especially motivated to do it. Perhaps I just wanted to start my own project, in a less popular niche. I wanted to give something back- to share some of what I’ve learned. Sharing market commentary on a daily basis was also keeping me focused, and the site became a great tool to improve my own discipline and to keep track of my own expectations: a hobby, a playground, a serious project â€" a little bit of everything.  
Site monetization was of course another reason â€" who would refuse some extra money?!

Forex Blog: Can you explain your approach to trading? Do you prefer fundamental analysis, technical analysis, or a mix of both?

I prefer the technical approach. When it comes to my own trading, I am a market follower. I don’t make predictions, I don’t ask questions, and I don’t seek answers. The FX Market is way too sensitive to all kind of events, both expected and unexpected. I believe that everything is reflected in market prices, so I prefer to concentrate on prices rather than analyzing the impact of every single economic data release. I don’t have enough time or skill to do that. I do care, however, about really significant things, such as quantitative easing, interest rates decisions and differentials, unemployment, bailouts, debt restructuring etc.

Forex Blog: You’ve written quite a bit about the EUR/USD. What do you make of the fact that the Euro is now rising rapidly, in spite of the unresolved sovereign debt crisis? Do you think the Euro will continue appreciating, or is it due for a correction?

EURUSD is one of the best pairs that reflects the dollar’s weakness nowadays. So this rally is not mainly about the EUR strength but rather about dollar’s weakness. Both currencies have their own major problems but recent and upcoming rate hikes by the ECB are making the euro more attractive relative to the US dollar.

Forex Blog: The Japanese Yen continues to behave erratically. After rising to a record high following the triple disaster, it proceeded to fall rapidly on the G7 intervention, only to resume its rise. What do you make of all of this. Under these conditions, is it even worth trying to formulate a fundamental trading strategy, or do you think traders should stick to technical analysis and short-term positions?

Recent history has shown that CB interventions in currency markets are ineffective and they are only causing massive short-term spikes. Although I prefer to stick to short-term predictions, I think that in the long run, both JPY and CHF will maintain their safe-haven status and will continue to strengthen against the US dollar.

Forex Blog: You recently observed that, “Nobody pays attention anymore to what the rating agencies have to say…” Why do you think this is the case? If the ratings agencies are indeed useless, how do you think individual traders gauge the seriousness of countries’ fiscal problems and the likelihood of default?

Most traders should be aware of the role the rating agencies played in the sub-prime crisis, and they were the main enablers of the financial meltdown. Well, it’s clear that fewer people care about what the rating agencies have to say. I certainly hope that traders and investors are more careful now, after the rating agencies missed both the sub-prime crisis and the eurozone debt crisis. Secondly, I don’t think we need the rating agencies to compete with each other to be the first to downgrade everything nowadays, playing the “Captain Obvious” role and telling us how troublesome sovereign debt really is. Most people can do their own research, especially large funds.  

Unfortunately, for all the flaws the “Big 3″ rating agencies have demonstrated, I think it’s a bit hard â€" but definitely not impossible â€" to find a better system. If governments would rate their own securities it would be totally pointless â€" obviously. So we shouldn’t even consider this option.

Changing the business model, making the bond buyer to pay the ratings agency instead of bond issuer probably won’t do any good either. Another option may be the Credit Default Swaps spreads, which represent more reliable data sources and viable alternatives to credit ratings.

Forex Blog: You occasionally offer “setups” to your readers. How are these designed to be used? Do you use these same setups as a basis for your own trades?

As you noted, I share charts, commentary and trade setups on regular basis.  
They are some of my own trades and intentions. As far as I know, most of my readers use their own analysis and strategies to make trading decisions and that’s what I highly recommend to beginners. All traders should do their own research before making any trading decisions. I learned that myself when I was still new to trading. I know that sometimes it is useful to read what other people expect and what strategies they use, especially when you are taking your first steps towards trading. Learning from others’ mistakes is better and more fun than learning from your own.

Forex Blog: InnerFX contains a great economic calendar that is very user-friendly. Given the abundance of economic data that is released every day, how can traders profit from this information? Which economic indicators are on your watch-list this week?

The Economic Calendar is provided by Forex Pros and is quite similar to other calendars you can find. I check it each morning in order to be aware of important economic releases and reports: I just don’t want to jump into trades a few minutes before Interest Rate Decisions or other key events. The most important events on my watch-list this week are the ECB Rate Decision and accompanying Press Conference and, of course, the NFP on Friday.

Forex Blog: Finally, what’s your advice for traders that want to beat the market and turn a profit in these uncertain times?

When it comes to trading, times will always be uncertainty: bubbles, crises, wars, rumors, lies, interventions, market manipulation etc. â€" we won’t get rid of them. My advice for traders is to have realistic goals and trade what they see, not what they think and preferably not what other people say.  
Also, don’t over-complicate trading and research. One who really understands how the market works can make great trades even if he doesn’t use any charts or indicators at all.

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Korean Won Poised for Further Gains

It was in November 2010 that I last blogged about the South Korean Won. As a result of the standoff with North Korea and a recent flareup in the Eurozone sovereign debt crisis, the Won had plummeted. Still, I viewed these as temporary problems and concluded that, “Ultimately, both the EU fiscal crisis and the tensions with North Korea will subside, which should cause the Won to resume its rise.” Since then, the Won has indeed risen by more than 8% against the US dollar. Rather than call for a correction, however, I’m ignoring my best instincts and arguing in favor of a further rise.

In a nutshell, the Korean Won has almost everything going for it at the moment. In the words of one columnist, “South Korea is today the 15th largest global economic power [and] is also the leading global nation in shipbuilding, production of LCD screens and in the distribution of broadband per capita. It is the third leading nation in the production of semi-conductors, the fifth in automobile manufacturing and in scientific research.” GDP is growing at a healthy clip of 4.2%. After recording real GDP growth in excess of 6% in 2010, South Korea’s economy is projected to grow by a further 4.5% in 2011, which means that it has more than made up for the recession that it suffered alongside the rest of the word in 2008-2009.  Exports reached a record level in 2010, propelling Korea’s current account balance well into surplus. “It seems that a target of $1 trillion of trade this year will be achieved, in spite of unfavorable conditions from the massive quake in Japan and the Middle East unrest,” declared Korea’s commerce minister. On balance then, money coming into Korea well exceeds money flowing out.

Moreover, unlike Japan and China â€" both of whose currencies are hovering around record levels â€" the Korean Won remains about 20% below its 2008 pre-credit crisis high. That means that the Won has plenty of scope for further appreciation before its exporters will be squeezed to the same extent as its Asian competitors. If the Bank of Korea (BOK) has its way, it will be a long time before this even happens. The BOK continues to intervene on behalf of the Won on a daily basis, and as a result, its foreign exchange reserves have risen to $300 billion, a record high.

Granted, Korean inflation is also rising, and most recently touched 4.7%, which is at or above the level in neighboring economies. The Bank of Korea has taken steps to counter this, but it is understandably wary about inadvertently stoking speculative interest in the Won. Thus, it has raised its benchmark interest rate only four times since last summer, and the rate is still at a historically low level. According to the Wall Street Journal, “That’s still well below the 4% to 4.5% level where economists estimate the neutral policy rate to be.”

When you consider both that the carry trade is back in vogue and that most other emerging market currencies have recovered most of their credit crisis losses and then some, it’s downright surprising that the Won hasn’t risen more. Perhaps, lamented one commentator, South Korea still lacks cachet among investors and is known more as the political counterbalance to North Korea than as the economic juggernaut that it has become. Even though its economy is larger than that of Australia, the Won doesn’t have nearly as much appeal as the Aussie.

Since it’s the weekend, I’ll keep this post short and sweet! Suffice it to say that the Won still has plenty of scope for further appreciation, and unless the BOK completely avoids hiking rates, I don’t see real downside pressures. At this rate, it will probably be one of the big success stories of 2011.

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Bin Laden Bounce!

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By Mike Conlon | May 2, 2011

Overnight it was revealed that Osama Bin Laden has finally been brought to justice and was killed by US forces. The sense of relief that came over the markets may be short-lived however as there are still many sources of risk in the global economy, each posing a different threat.

Oil sold off immediately on the news and stocks are higher to start the day and while this certainly is an important development, it may not be enough to reverse recent trends. Those trends of course are a weak US dollar and higher commodity prices, especially oil.

This week there are a few rate policy decisions that we need to keep an eye on: Australia on Tuesday and Europe and the UK on Thursday.

In addition, the US Non-Farm Payrolls report is due out on Friday and this leading indicator may show whether or not the economy is on the mend. It is expected that we will add 190K jobs and that the unemployment rate will remain steady at 8.8%.

With the end of QE2 coming next month, it will be interesting to see if the old market adage, “sell in May and go away” has any merit.

In the forex market:

Aussie (AUD): The Aussie is mostly lower despite the risk appetite in the market as home prices came in lower than expected. This comes a day ahead of the RBA rate policy meeting where it is expected that they will leave rates unchanged at 4.75%. The Aussie eclipsed 1.10 vs. USD earlier this morning. (Click chart to enlarge)

Kiwi (NZD): The Kiwi is mixed as well as the US dollar is picking up a little strength this morning as commodity prices are lower to start the day. Employment figures are due out in New Zealand on Wednesday.

Loonie (CAD): The Loonie is mostly lower as oil prices have pulled back from recent highs on the Bin Laden news. However, it must be noted that oil is still trading above $112. Canadian employment figures are due out on Friday.

Euro (EUR): Euro zone PMI figures came in this morning better than expected and Thursday’s rate policy decision will be important as even though there is no change expected, the accompanying statement could provide more clarity into whether or not the ECB will tighten further in the ensuing months. (Click chart to enlarge)

Pound (GBP): The Pound is mixed this morning as home prices stayed steady in the UK, halting previous declines. The BOE rate policy decision on Thursday is also expected to yield no change but unlike the ECB, there will be no policy statement so this decision may have less impact than that of the ECB.

Dollar (USD): It is always good to get news that can give people hope however once the reality of current economic conditions comes back into focus, there could be continued worry. The Non-Farm payrolls report due out on Friday will be an important metric to watch, but stocks and commodities prices may ultimately tell the story.

Yen (JPY): The Yen is weaker across the board as some sense of risk-taking has reduced demand for the safe haven. The Nikkei average made it back to just over 10K for the first time since the natural disaster took place.

While it is definitely a bittersweet moment to know that Osama Bin Laden is no more, it would be a major mistake to think that terrorism has ended. There is still considerable risk in the world today, and the conflict in Libya and various other regions remind us of it daily.

While a slowing economy here in the US is a major problem, commodity price inflation due to loose monetary policy may be a bigger detriment. The US dollar has been the worst-performing currency over the last three months so this is no coincidence.

Whether or not the end of QE2 will bring about further declines is anyone’s guess at this point but one thing is certain: there may be some bumps and bruises to the economy once the training wheels are removed and it will be interesting to see if the economy can function on its own!

To learn more about how you can take advantage of world events through the currency market, be sure to check out our currency trading courses!

To follow these events live with a free, real-time practice account, click here! Don’t miss out on the world’s fastest growing market!

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US Home Prices Decline

For the eighth straight month, the price for single-family homes fell in February. The S&P/Case Shiller composite index â€" which measure home prices for twenty cities across America â€" declined by 0.2 percent.

“There is very little, if any, good news about housing. Prices continue to weaken, trends in sales and construction are disappointing,” David Blitzer, chairman of the Index Committee at S&P Indices, said in a statement.

“Recent data on existing-home sales, housing starts, foreclosure activity and employment confirm that we are still in a slow recovery.”

Source: Bloomberg

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Transparency But Not Truth!

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By Mike Conlon | April 26, 2011

Tomorrow will the be the first of the new, transparent Fed where Bernanke will attempt to get out in front of the population and attempt to get people to suspend their disbelief. While the Fed Chairman is clearly on the wrong side of public opinion with QE2 and the inflation it has caused, trying to convince people that what they are feeling in the economy is wrong just won’t work.

The reason is because there will be no truth to go along with the transparency. It will be very difficult to sway public opinion that there is no inflation when people see it in their daily lives. The debate over which metric of CPI to use to see the true effects of policy have left people with a lack of confidence in those in power. How this speech tomorrow will change this sentiment is anyone’s guess.

So in my opinion this will all amount to much ado about nothing, with the markets hanging on every word spoken, though I don’t think we will learn anything new.

Europe is open again after yesterday’s holiday and European stocks are higher as are US equity futures to start the day. Asian stocks were lower as are commodities, though today can’t be classified as either a risk-taking or risk-averting day.

In the forex market:

Aussie (AUD): The Aussie is higher as interest rate differentials and carry trades are driving market sentiment despite mild risk taking in the marketplace. An index of leading indicators came in higher than expected.

Kiwi (NZD): The Kiwi is the biggest gainer this morning ahead of tomorrow’s rate policy decision as maybe the market is sensing that the RBNZ could turn hawkish again. While the current expectation is the rates will be left unchanged, the added benefit of Dollar weakness has been driving price action.

Loonie (CAD): The Loonie is also mostly higher despite oil prices pulling back to just above $112. Friday’s GDP report will give more clarity into the Canadian economic situation.

Euro (EUR): The Euro is mixed this morning as both Dollar and Yen are weaker, though reports about a possible Greek debt restructuring have left the market un-phased. CPI data due out tomorrow is expected to show higher inflation.

Pound (GBP): The Pound is lower across the board ahead of tomorrow’s GDP report. CBI business optimism figures came in slightly lower than expected, and perhaps the distraction of the Royal wedding later this week has left the markets unimpressed with the Pound. (Click chart to enlarge)

Dollar (USD): The Dollar is weaker across the board ahead of tomorrow’s Fed meetings. There is increased speculation that the Fed will somehow try to continue to support the economy even though QE2 is expected to end in June. Consumer confidence figures are due out later this morning.

Yen (JPY): The Yen is also lower as the expectation of continued weak monetary policy has pushed traders toward higher yielding currencies. Retail sales figures are expected to show big declines later this evening, ahead of Thursday’s rate decision.

While I expect little in the way of learning something new tomorrow from the Fed, there is always the possibility of a surprise. However, the Fed has been pretty clear about its stance and its denials of inflation so I highly doubt that will change anytime soon.

But the market may be more concerned with how the Fed plans to exit QE2 and what that will do to the economy. What is clear is that the Fed needs to pick up the slack for the inaction occurring on the fiscal side of the equation, with politicians in Washington unable to work together.

Don’t expect to walk away from this new Fed format tomorrow with a warm and fuzzy feeling about the direction the US is going, and continue to be cautious. While there is always major volatility surrounding the FOMC meetings, I could see tomorrow turning out to be one big dud.

To learn more about how you can take advantage of world events through the currency market, be sure to check out our currency trading courses!

To follow these events live with a free, real-time practice account, click here! Don’t miss out on the world’s fastest growing market!

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Greek Debt Higher Than Expected

Greece’s deficit for 2010 was a higher-than-expected 10.5 percent for 2010 surpassing the projected 9.4 percent shortfall by more than a full percentage point. The news sent Greek bond yields higher and drew fresh comments suggesting Greece will require further assistance to avoid insolvency.

“I don’t think that Greece will succeed in this consolidation strategy without any restructuring in the future, or perhaps also in the near future,” Lars Feld, a member of the German government’s council of economic advisers, told Bloomberg Television’s Nicole Itano in Frankfurt. “Greece should restructure sooner than later.”

Source: Bloomberg

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Economic Theory Implies Canadian Dollar will Fall

Sometimes I wonder if I’m living in the clouds. All of my recent reports on the Canadian dollar were twinged with pessimism, and I argued that it would only be a matter of time before reality caught up with theory. While the continued surge in commodities prices has confounded everyone’s expectations, but other economic trends continue to work against Canada. In other words, I think that there is still a strong argument to be made for shorting the loonie.

To be sure, the rally in commodities prices has been incredible- nearly 50% in less than a year! Oil prices are surging, gold prices just touched a record high, and a string of natural disasters have driven prices for agricultural staples to stratospheric levels. Given the perception of the Canadian dollar as a commodity currency, then, it’s no wonder that rising commodity prices have translated into a stronger currency.

As I’ve argued previously, rising commodities prices are basically an irrelevant â€" or even distracting â€" factor when it comes to analyzing the loonie. That’s because, contrary to popular belief, commodities represent an almost negligible component of Canada’s economy. Canadian exports, of which commodities probably account for half, have recovered from the recession lows of 2009. On the other hand, the value of Canadian exports are basically the same as they were 10 years ago, when one US dollar could be exchanged for 1.5 Canadian dollars.

Consider also that Canada now imports more than it exports, and that the Canadian balance of trade recently dipped into deficit for the first time since records started being kept 40 years ago. Its current account has similarly plunged, as Canadians have had to finance this through loans and investment capital from abroad. Based on the expenditure approach to GDP, trade actually detracts from Canadian GDP. Any way you perform the calculations, commodities are hardly the backbone of its economy, account for about 15% at most.

As if that weren’t enough, the press is full of stories of Canadians that think their own currency is overvalued. Businesses complain that they can’t compete, and that banks won’t lend them the money they need to upgrade their facilities and become more efficient. Meanwhile consumers whine about higher prices in Canada, compared to the US. I think it’s very telling that their is now a 2-hour wait to cross the border from Vancouver, and shopping malls on the American side have reported a huge jump in business. Even the famous Big Mac Index shows that the price of a hamburger was already 12% higher in Canada back when the loonie was still hovering around parity with the US Dollar.

One area that higher commodities prices will be felt is inflation, which is nearing a two-year high and rising. At 3.3%, Canada’s CPI rate is now higher than in the EU. Given that the European Central Bank hiked rates earlier this month, it probably won’t be long before the Bank of Canada follows suit. In fact, forecasters expect the benchmark rate to rise by 50-75 basis points by the end of the year, from the current 1%.

This might excite carry traders, but probably few others. Besides, given that other central banks will probably raise rates concurrently, it can’t be assumed that carry traders will automatically gravitate towards the Canadian dollar. Not to mention that as I pointed out in my previous post, the carry trade is hardly a risk-free proposition. In this case, an interest rate differential of only 1-2% probably isn’t enough to compensate for the risk of a correction in the USD/CAD.

And that is exactly what I expect will happen. The fact that the loonie has shattered even the most optimistic forecasts is not cause for bullishness, but rather for concern. According to the most recent Commitment of Traders report, net long positions are reaching extreme levels, and it’s probably only a matter of time before the loonie returns to earth.

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Good Friday!

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By Mike Conlon | April 22, 2011

But not good for forex trading!  Central banks are closed around the globe so liquidity is absent from the market.

I would avoid trading today even though the forex market is open, unless you want to line your broker’s pocket!

Happy Easter to those who celebrate it! 

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Forex Week in Review: April 16-21

It was a compact volatile trading week with the dollar hemorrhaging against all of its G10 trading partners and that includes Japan. With rate divergence influencing trade positions, this dollar bear market potentially still has ways to go. Some of the market moves have been exaggerated because of the lack of holiday liquidity, but, the dollars intention remains the same, and that is to underperform. The last dollar bear market between 1985 and 95 implies that the buck has ‘approximately-2% further to fall to match its depreciation at the same point in the bear cycle’.

EUROPE

• Greek government denies press reports on restructuring.
• Finnish elections saw an unexpectedly strong showing for the anti-EU True Finns party. The result could complicate negotiations over an EFSF package for Portugal and the mechanism for enlarging the EFSF.
• Spain successfully auctioned their bills, but at a lower bid-to-cover than at the previous auction.
• Euro-zone flash PMI’s surprised to the upside (57.7 vs. 57.5), showing little negative impact from the Japanese earthquake or higher oil prices.
• German PMI manufacturing on hold at record highs (61.7).
• Euro-zone services PMI moderated slightly from 57.2 in March to 56.9 in April, held down by a lower German print. The surveys continue to be consistent with very strong GDP growth at around 3% and supports expectations of additional ECB tightening, while at the same time reducing the expected impact of fiscal stress in the periphery.
• Finnish Prime Minister-elect backs Portuguese EFSF, but suggested that the Portuguese program may require some changes to secure Finnish approval.
• Riksbank hiked +25bp to +1.75% and revised CPI forecast higher.
• Spain sold €2.4b of 2021 bonds and €885.2m of 2024 paper to strong demand, supporting market expectations of the sovereign’s ability to weather its maturity schedule without resorting to EFSF funding.
• BoE April Minutes showed an unchanged voting pattern. Six members voted for leaving rates unchanged and three members voted for a rate hike. The sentence, indicating that some members from the dovish camp saw the case for rate hikes strengthening has been removed.
• Greek inverted 2/10’s yield curve spread reaches fresh extremes-1,244bp
• A soft German Ifo print for April (110.4 vs. 111.1). The level continues to point to very solid growth.
• UK Retail sales surprised to the upside with a +0.2%, m/m, gain in March (ex-petrol). In real terms, sales are flat on the quarter and rising only +1.0%, q/q in nominal terms due to the VAT hike in January. No real reason to hike rates any time soon.
• M3 and mortgage growth remained steady in Switzerland. M3 growth moderated slightly to +7.1%, y/y, while mortgages grew at +4.5%, y/y. This is should not impose any pressure on the SNB to consider policy tightening.

Americas

• S&P cut the US long-term credit outlook. “The US government risks losing its AAA credit rating unless policy makers agree on a plan by 2013 to reduce budget deficits and the national debt”.
• March US headline housing starts (+7.2% or 0.55m) bounced back from February’s very low levels (-18.5%), but the details suggests the US housing sector remains very weak. Building permits have climbed +11.2%, m/m, to an annual rate of +594k. However, year-over-year, overall new home construction was down -13.4%.
• Canadian inflation data beat all analysts expectations, marking the biggest monthly headline gain in 20-years (+1.1% vs. +0.3%) and the largest annual advance in nearly three-years (+3.3%). It puts the Governor on the back foot to hike in July.
• Canadian leading index rose faster than expected last month (+0.8% vs. +0.5%), it’s sixth consecutive gain, led by increases in the stock market (+2.2%) and housing index (+2.2%).
• US Sales of existing homes rose slightly last month (+3.7% to a seasonally adjusted +5.10m), but prices remain weak. The median sales price for an existing home was $159k, down -5.9% from the revised year-ago median.
• Canadian retail sales posted its first positive print in both nominal and real terms in February, providing a lift to February GDP growth. Headline retail sales rose at a slightly slower pace than expected in February, up 0.4% m/m versus expectations of a 0.5% m/m gain, while core sales accelerated by 0.7% m/m as auto sales dipped for a third consecutive month.
• US initial jobless claims fell less than expected last week, remaining above 400,000 for the second consecutive week. Both the extended benefits and emergency unemployment compensation benefits experienced declines.
• Philly Fed’s Business Outlook Survey plunged from +43.4 to +18.5

ASIA

• PBoC hikes reserve requirements another +50bp, for a cumulative +450bp of hikes since the cycle began. Market now expects the PBoC to hike the RRR another +150-250bp and the lending/deposit rates a further +135bp/150bp.
• NZD has sold off after proving resilient to last week’s carry-trade correction, the catalyst being weaker-than-expected CPI inflation of +0.8%.
• PBoC governor Zhou stated that China’s central bank FX reserves, which rose about +$200b into +$3trn in the first quarter, had exceeded a reasonable level and may have led to excessive liquidity and had exerted significant sterilization pressure.
• It’s rumored that the Aussie government is considering tax breaks on foreign sovereign investments in Australia, a good enough reason to want to own the highest yield G10 currency.
• Australia witnessed a stronger terms-of-trade, where export prices rose +5.2% and import prices rose +1.4%, q/q, pushing the terms-of-trade close to their 2008 and 2010 highs. This will give the RBA a good enough reason to want to raise interest rates (+4.75%).

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Icelandic Kronur: Lessons from a Failed Carry Trade

A little more than two years ago, the Icelandic Kronur was one of the hottest currencies in the world. Thanks to a benchmark interest rate of 18%, the Kronur had particular appeal for carry traders, who worried not about the inherent risks of such a strategy. Shortly thereafter, the Kronur (as well as Iceland’s economy and banking sector) came crashing down, and many traders were wiped out. Now that a couple of years have passed, it’s probably worth reflecting on this turn of events.

At its peak, nominal GDP was a relatively modest $20 Billion, sandwiched between Nepal and Turkmenistan in the global GDP rankings. Its population is only 300,000, its current account has been mired in persistent deficit, and its Central Bank boasts a mere $8 Billion in foreign exchange reserves. That being the case, why did investors flock to Iceland and not Turkmenistan?

The short answer to that question is interest rates. As I said, Iceland’s benchmark interest rate exceeded 18% at its peak. There are plenty of countries that offered similarly high interest rates, but Iceland was somehow perceived as being more stable. While it didn’t apply to join the European Union (its application is still pending) until last year, Iceland has always benefited from its association with Europe in general, and Scandinavia in particular. Thanks to per capita GDP of $38,000 per person, its reputation as a stable, advanced economy was not unwarranted.

On the other hand, Iceland has always struggled with high inflation, which means its interest rates were never very high in real terms. In addition, the deregulation of its financial sector opened the door for its banks to take huge risks with deposits. Basically, depositors â€" many from outside the country â€" parked their savings in Icelandic banks, which turned around and invested the money in high-yield / high-risk ventures. When the credit crisis struck, its banks were quickly wiped out, and the government chose not to follow in the footsteps of other governments and bail them out.

Moreover, it doesn’t look like Iceland will regain its luster any time soon. Its economy has shrunk by 40% over the last two years, and one prominent economist has estimated that it will take 7-10 years for it to fully recover. Unemployment and inflation remain high even though interest rates have been cut to 4.25% â€" a record low. The Kronur has lost 50% of its value against the Dollar and the Euro, the stock market has been decimated, and the recent decision to not remunerate Dutch and British insurance companies that lost money in Iceland’s crash will only serve to further spook foreign investors. In short, while the Kronur will probably recover some of its value over the next few years (aided by the possibility of joining the Euro), it probably won’t find itself on the radar screens of carry traders anytime soon.

In hindsight, Iceland’s economy was an accident waiting to happen, and the global financial crisis only magnified the problem. With Iceland â€" as well as a dozen other currencies and securities â€" investors believed they had found the proverbial free lunch. After all, where else could you earn an 18% by putting money in a savings account? Never mind that inflation was just as high; with the Kronur rising, carry traders felt assured that they would make a tidy profit on any funds deposited in Iceland.

The collapse of the Kronur, however, has shown us that the carry trade is anything but risk-free. In fact, 18% is more than what lenders to Greece and Ireland can expect to earn, which means that it is ultimately a very risky investment. In this case, the 18% that was being paid to depositors were generated by making very risky investments. As the negotiations with the insurance companies have revealed, depositors had nothing protecting them from bank failure, which is ultimately what happened.
Now that the carry trade is making a comeback, it’s probably a good time to take a step back and re-assess the risks of such a strategy. Even if Iceland proves to be an extreme case â€" since most countries won’t let their banks fail â€" traders must still acknowledge the possibility of massive currency depreciation. In other words, even if the deposits themselves are guaranteed, there is an ever-present risk that converting that deposit back into one’s home currency will result in losses. That’s especially true for a currency that is as illiquid as the Kronur (so illiquid that it took me a while to even find a reliable quote!), and is susceptible to liquidity crunches and short squeezes.

When you enter into a carry trade, understand that a spike in volatility could wipe out all of your profits in one session. The only way to minimize your risk is to hedge your exposure.

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A Familiar Game!

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By Mike Conlon | April 18, 2011

The markets are starting the week lower as risk aversion is dominating the action in this holiday-shortened week. In what has become a familiar scene, oil is trading lower as it gets bid up on Friday’s as market participants do not want to go short over the weekend as the risk in the Arab countries is still present.

Adding to risk sentiment are the usual Euro debt crisis rumors, which propose that rate hikes are going to cause Greece and Ireland to default. While this has to be a concern for the ECB, I’m surprised that more clarity isn’t being proffered. Perhaps some Euro weakness in the face of rising rates would be just what the ECB is hoping will happen.

In an attempt to slow down inflation, China raised the reserve requirements for banks again which is intended to curb lending.

Overnight, New Zealand reported CPI data that showed that inflation increased slightly less than expected. In the UK, asking prices for homes came in higher as lack of supply and overall inflation contribute to seller confidence. I guess it doesn’t hurt that London has become the “preferred destination” of former Arab dictators so the market could remain strong for some time.

It will be interesting to see if the US market can shake off the lower start and turn it around by the end of the day. Recently, the US market has seemed immune to negative news and keeps going higher, as Bernanke’s dollar destruction leaves traders few other alternatives.

In the forex market:

Aussie (AUD): The Aussie is mostly lower on risk aversion, but is faring better than the other commodity currencies due largely to its interest rate differential. The minutes from the RBA rate policy meeting are due out tomorrow, which I expect to have a dovish tone as a result of the recent run-up.

Kiwi (NZD): The Kiwi is lower across the board as CPI data came in lower than expected, perhaps dampening hopes of a rate hike any time soon. CPI showed a quarterly increase of .8%, pushing the YoY number to 4.5%, vs. expectations of 1% and 4.6% respectively. (Click chart to enlarge)

Loonie (CAD): The Loonie is also lower as oil has pulled back a day ahead of the release of CPI data. While Canada has not been seeing the inflation that some other regions have, building permits and housing starts figures will show whether or not the economy is moving forward.

Euro (EUR): The Euro is lower against all but the Kiwi as the rumors of a Greek debt restructuring and a possible block of aid to Portugal are making the rounds. PMI data is expected to contract slightly, and PPI data is expected to increase. (Click chart to enlarge)

Pound (GBP): The Pound is mixed under what would be considered a “normal” risk aversion day despite the fact that home asking prices came in higher than expected. The BOE rate policy meeting minutes will be released on Wednesday which could show increased worry over inflation. Retail sales figures come out on Thursday.

Dollar (USD): The Dollar is mostly higher on risk aversion, and Friday markets are closed here in the US. It’s a light week for news in the US, without today bringing some Fedspeak at various locations, and the Philly Fed is due out on Thursday, which could see higher volatility as we have a long market weekend.

Yen (JPY): The Yen is higher across the board on risk aversion as Asian markets were down over night. Trade balance figures are due out on Tuesday night, and I am a little surprised to see Yen continue to strengthen considering the major economic challenges they are facing.

We’ve seen this one before, folks. The markets push both oil prices higher on Friday’s because of the risk in the marketplace and when nothing significant happens, it sells off going into Monday. This helps take markets down (which isn’t a bad thing), and then US stocks tend to rebound to start the week. Rinse and repeat.

Except there is going to be the time when this game does not work, and the selling that starts the day could bring about a “big one”. The markets have been so pumped up on Fed easy-money steroids that sooner or later the bubble is going to burst. What the exact catalyst will be is anyone’s guess but at this point these markets are climbing the “wall of worry.”

In times like these it makes sense to proceed cautiously as no one knows where or when the next risk event may come from.

To learn more about how you can take advantage of world events through the currency market, be sure to check out our currency trading courses!

To follow these events live with a free, real-time practice account, click here! Don’t miss out on the world’s fastest growing market!

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UK Growth Expected to Decline

The British economy continues to wrangle with very weak growth even as consumers are being hammered by surging prices. The result is an inflation rate double the target “ideal” of two percent annual inflation. And while the last few years have not been a walk in the park, there appears little prospect for immediate relief.

In a speech delivered in mid December, Charles Bean, Deputy Governor for Monetary Policy and member of the Monetary Policy Committee (MPC), noted that the economy is showing signs of improvement, but cautioned that “it may be some while yet before normality is restored”.

That assessment was made four months ago and one would be hard-pressed to see any progress since then. Indeed, for the first quarter of the year, the situation may have actually worsened.

For four straight quarters in 2010, Gross Domestic Product made positive gains yet for the first quarter of this year, GDP actually fell by 0.5 percent. Despite this, the government still expects growth for the full year to be in the range of 1.7 percent â€" this may prove to be a bit optimistic.

Last week, the International Monetary Fund (IMF) reduced its outlook for the UK from 2 percent growth to 1.7 percent. The Organization for Economic and Development (OECD) cut its position even deeper dropping its earlier 1.7 percent prediction to just 1.5 percent. This makes it unanimous â€" the 2011 perspective for the British economy is actually bleaker now than at the beginning of the year.

Adding to the quandary is that consumer prices are rising at a much faster rate than overall growth. According to Britain’s Office for National Statistics, consumer prices rose another four percent in March following a 4.4 percent increase in February. The resulting inflation is rapidly outpacing gains in salaries and wages and is seriously undermining consumer buying power.

Consumer Price Index â€" Annualized Rate

Nov 2010 â€" 3.2%
Dec 2010 â€" 3.3%
Jan 2011 â€" 4.0%
Feb 2011 â€" 4.4%
Mar 2011 â€" 4.0%

 
Will Get Worse Before It Gets Better

Like several other developed economies, England faces a huge deficit made worse by the recession’s double whammy of reduced tax revenues and greater expenses arising from monetary stimulus to support the economy. Truth be told however, Britain has struggled with deficits for many years now and the situation has finally reached the point where it can no longer be ignored. Even with higher revenues expected this year, the budget shortfall for the current year is estimated at £140 billion (US$228.5 billion).

In its last budget, the government outlined plans to introduce significant spending cuts to the tune of £83 billion (US$133.5 billion) over the next four years. This is thought to be sufficient to balance the budget assuming higher government revenue as the economy recovers. This also assumes that the spending cuts will not impact those revenues and this is where things tend to get a bit sticky.

For the past six months, Bank of England Governor Mervyn King has argued against hiking interest rates to deal with the mounting inflation. King defends his position by blaming rising food and energy costs for a “temporary” spike in consumer prices suggesting that “core” inflation is actually quite low. King also suggests that as the impact of government’s spending cuts take effect, overall growth could decline even further.

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Where are Exchange Rates Headed? Look at the Data

At this point, it’s cliche to point to the so-called data deluge. While once there was too little data, now there is clearly too much, and that is no less true when it comes to data that is relevant to the forex markets. In theory, all data should be moving in the same direction. Or perhaps another way of expressing that idea would be to say that all data should tell a similar story, only from different angles. In reality, we know that’s not the case, and besides, one can usually engage in the reverse scientific method to find some data to support any hypothesis. If we are serious about finding the truth and not about proving a point, then, the question is: Which data should we be looking at?

I think the quarterly Bank of International Settlements (BIS) report is a good place to start. The report is not only a great-read for data junkies, but also represents a great snapshot of the current financial and economic state of the world. It’s all macro-level data, so there’s no question of topicality. (If anything, one could argue that the scope is too broad, since data is broken down no further than US, UK, EU, and Rest of World). The best part is that all of the raw data has already been organized and packaged, and the output is clearly presented and ready for interpretation.

Anyway, the stock market rally that began in 2010 has showed no signs of slowing down in 2011, with the US firmly leading the rest of the world. As is usually the case, this has corresponded with an outflow of cash from bond markets and a steady rise in long-term interest rates. However, emerging market equity and bond returns have started to flag, and as a result, the flow of capital into emerging markets has reversed after a record 2010. Without delving any deeper, the implication is clear: after 2+ years of weakness, developed world economies are now roaring back, while growth in emerging markets might be slowing.

Economic growth, combined with soaring commodities prices, is already producing inflation. (See my previous post for more on this subject). However, the markets expect that the ECB, BoE, and Fed (in that order) will all raise interest rates over the next two years. As a result, while investors expect inflation to rise over the next decade, they believe it will be contained by tighter monetary policy and moderate around 2-3% in industrialized countries.

The picture for emerging market economies is slightly less optimistic, however. If you accept the BIS’s use of China, India, and Brazil as representative of emerging markets as a whole, rising interest rates will help them avoid hyperinflation, but significant price inflation is still to be expected. I wonder then if the pickup in cross-border lending over this quarter won’t slow down due to expectations of diminishing real returns.

Any sudden optimism in the Dollar and Euro (and the Pound, to a lesser extent) must be tempered, however, by their serious fiscal problems and consequent volatility. As a result of the credit crisis (and pre-existing trends), government debt has risen substantially over the last three years, topping 100% of GDP for the US and 200% of GDP for Japan. Credit default swap rates (which represent the markets’ attempt to gauge the probability of default) have risen across the board. To date, gains have been highest for “fringe” countries, but regression analysis suggests that rates for pillar economies need to rise proportionately to account for the the bigger debt burden. According to a BIS analysis, US and UK banks are very exposed to Eurozone credit risk, which means a default by one of the PIGS would reverberate around the western world.

While I worry that such a basic analysis makes me appear shallow, I stand by this “20,000 foot” approach, with the caveat that it can only be used to make extremely general conclusions. (More specific conclusions naturally demand more specific data analysis!) They are that industrialized currencies (led by the Dollar and perhaps the Euro) might stage a comeback in 2011, due to stronger economic growth and higher interest rates. While GDP growth and interest rates will undoubtedly be higher in emerging markets, investors were extremely aggressive in pricing this in. An adjustment in theoretical models naturally demands a correction in actual emerging market exchange rates!

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Where's The Love?

« Out Of Touch! | Home

By Mike Conlon | February 14, 2011

Happy Valentine’s Day!Though there was no love for me this morning as I had some computer issues which have prevented me from doing a video this morning. Apologies to my audience.

And today there is also no love for the Euro, which is trading lower across the board as Portugal reported that its economy shrank by .3% last quarter for the first time in almost a year as government spending declined and taxes were raised. Portugal is potentially the next shoe to drop in the European debt crisis as there is still no meaningful resolution in place. Adding to Euro declines was the industrial production figures, which showed a slight decline in December.

Tomorrow is a news-worthy day; as the Euro zone will be reporting GDP figures.

This is also a big weak for the Pound, as tomorrow will bring CPI data which is expected to show rising inflation of 4%, nearly twice the BOE target. This will be followed on Wednesday by the BOE Inflation Report and jobless claims numbers which will show if there is any sign of a slow-down.

Japan will also have its rate policy decision tomorrow after reporting that GDP shrank less than expected. There is no change expected for the rate decision.

So today is kind of light on news, with important data due out later in the week. Markets are flat to slightly higher, electing to pause a bit after the excitement of Egypt last week. Going forward, it will be interesting to see if there is any contagion from the events that spread to other areas in the Middle East, and what that does to risk themes and markets overall.

In the forex market:

Aussie (AUD): The Aussie is higher across the board as gains in home loans rose more than expected. This helped prompt some risk appetite as Asian stocks were higher overnight, also benefiting from better than expected GDP in Japan and higher expected CPI data from China.  Tomorrow is the release of the RBA board meeting minutes.

Kiwi (NZD): Unfortunately for the Kiwi, it is not benefiting from risk appetite but perhaps that is helping to mitigate losses as retail sales figures came in worse than expected, showing a decline of 1.1% vs. an expectation of a decline of .4%.

Loonie (CAD): The Loonie is trading mostly higher as oil is slightly higher to start the day. On Friday, CPI data will be released which will show if there is any inflation that might concern the BOC and cause a potential rate hike in the near future.

Euro (EUR): The Euro is lower across the board after industrial production figures came in slightly lower than expected, showing a decline of .1% vs. an expectation of no change. In addition, Portugal’s reported GDP decline as the market re-focusing on debt as Portuguese bond yields are starting to rise. With no solution in sight to the debt crisis, keep an eye on Portugal as potentially the next domino to fall. (Click chart to enlarge)

Pound (GBP): The Pound is mostly higher ahead of tomorrow’s CPI and home price data and Wednesday’s Inflation Report from the BOE. The Central Bank may be running out of time to do something about monetary policy if inflation continues to rise and any rise in jobless claims will be perceived as negative.

Dollar (USD): The Dollar is trading mostly lower, as recent strength due to Euro weakness and risk aversion from Egypt have abated slightly. There’s no news here in the US today, but Tuesday will show advance retail sales figures followed by CPI data on Thursday. Expect the inflation talk to heat up this week, but with no real fixes in sight.

Yen (JPY): The Yen is also mixed this morning as GDP in Japan contracted less than expected, showing a decline of 1.1% vs. an expectation of a 2% decline. While the Japanese rate policy decision is expected to produce no change tomorrow, a focus is now on Japanese fundamentals could induce further weakness despite any risk events. (Click chart to enlarge)

There will be no love lost this week when some of the inflation data gets reported. Higher prices are being seen around the globe and this was one of the initial catalysts of the uprising in Egypt. It is only a matter of time before outrage reaches “most established� economies as well.

The UK will be first to react, as inflation there is approaching 4% and the BOE has still not made any changes. Here in the US, we will most likely be told again that there is no inflation so the Fed can maintain low interest rates. While the usual supply and demand rhetoric will be used to explain away the problem, I can assure you that low interest rates here in the US are one of the major contributing factors to global inflation.

It is no secret that the US is trying to inflate away its debt, and will attempt to do so on the back of the consumer. So keep an eye on the CPI data, and whether or not there is any public backlash over rising prices.

To learn more about how you can take advantage of world events through the currency market, be sure to check out our currency trading courses!

To follow these events live with a free, real-time practice account, click here! Don’t miss out on the world’s fastest growing market!

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Geithner Warns U.S. Debt to Hit Record

The U.S. has benefited from low-cost debt to rebuild the economy but the Treasury department issued a warning that the cost to service the debt will triple as interest rates rise. By 2016, it is expected that the interest cost alone to service the debt will reach 3.1 percent of Gross Domestic Product.

“It’s a slow train wreck coming and we all know it’s going to happen,” said Bret Barker, an interest-rate analyst at Los Angeles-based TCW Group Inc. “It’s just a question of whether we want to deal with it. There are huge structural changes that have to go on with this economy.”

Source: Bloomberg

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Forex Markets Look to Interest Rates for Guidance

There are a number of forces currently competing for control of forex markets: the ebb and flow of risk appetite, Central Bank currency intervention, comparative economic growth differentials, and numerous technical factors. Soon, traders will have to add one more item to their list of must-watch variables: interest rates.

Interest rates around the world remain at record lows. In many cases, they are locked at 0%, unable to drift any lower. With a couple of minor exceptions, none of the major Central Banks have yet raised their benchmark interest rates. The same applies to most emerging countries. Despite rising inflation and enviable GDP growth, they remain reluctant to hike rates for fear that they will invite further speculative capital inflows and consequent currency appreciation.

Emerging markets countries can only toy with inflation for so long. Over the medium-term, all of them will undoubtedly be forced to raise interest rates. The time horizon for G7 Central Banks is a little longer, due to high unemployment, tepid economic growth, and price stability. At a certain point, however, inflation will compel all of them to act. When they raise rates â€" and by much â€" may well dictate the major trends in forex markets over the next couple years.

Australia (4.75%), New Zealand (3%), and Canada (1%) are the only industrialized Central Banks to have lifted their benchmark interest rates. However, the former two must deal with high inflation, while the latter’s benchmark rate is hardly high enough for carry traders to take interest. In addition, the Reserve Bank of Australia has basically stopped tightening, and traders are betting on only one or two 25 basis point hikes in 2011. Besides, higher interest rates have probably already been priced into their respective currencies (which is why they rallied tremendously in 2010), and will have to rise much more before yield-seekers take notice.

China (~6%) and Brazil (11.25%) are leading the way in emerging markets in raising rates. However, their benchmark lending rates belie lower deposit rates and are probably negative when you account for soaring inflation in both countries. The Reserve Bank of India and Bank of Russia have also hiked rates several times over the last year, though again, not yet enough to offset rising prices.

Instead, the real battle will probably be fought primarily amongst the Pound, Euro, Dollar, and Franc. (The Japanese Yen is essentially moot in this debate, and its Central Bank has not even humored the markets about the possibility of higher interest rates down the road). The Bank of England (BoE) will probably be the first to move. “The present ultra-low rates are unsustainable. They would be unsustainable in a period of low inflation but they are especially unsustainable with inflation, however you measure it, approaching 5 per cent,” summarized one columnist. In fact, it is projected to hike rates 3 times over the next year. If/when it unwinds its quantitative easing program, long-term rates will probably follow suit.

The European Central Bank will probably act next. Its mandate is to limit inflation â€" rather than facilitate economic growth, which means that it probably won’t hesitate to hike rates if inflation remains above its 2% threshold. In addition, the front runner to replace Jean-Claude Trichet as head of the ECB is Axel Webber, who is notoriously hawkish when it comes to monetary policy. Meanwhile, the Swiss National Bank is currently too concerned about the rising Franc to even think about raising rates.

That leaves the Federal Reserve Bank. Traders were previously betting on 2010 rate hikes, but since these have failed to materialized, they have pushed back their expectations to 2012. In fact, there is reason to believe that it will be even longer than that. According to a Bloomberg News analysis, “After the past two U.S. recessions, the Fed didn’t start raising policy rates until joblessness had fallen about three- quarters of the way back to the full-employment level…To satisfy that requirement, the jobless rate would need to be 6.5 percent, compared with today’s 9 percent.” Another commentator argued that the Fed will similarly hold off raising rates in order to further stabilize (aka subsidize) banks and to help the federal government lower the real value of its debt, even if it means tolerating slightly higher inflation.

When you consider that US deposit rates are already negative (when you account for inflation) and that this will probably worsen further, it looks like the US Dollar will probably come out on the losing end of any interest rate battles in the currency markets.

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Has the Swiss Franc Reached its Limit?

The second half of 2010 witnessed a 20% rise in the Swiss Franc (against the US Dollar), which experienced an upswing more closely associated with equities than with currencies. It has managed to entrench itself well above parity with the Dollar, and has become a favored destination for investors looking for a safer alternative to the Euro. Still, there are reasons to wary, and it could be only a matter of time before the CHF bull market comes to a screeching halt.

The forces behind the Franc’s rise are easily identifiable. It basically comes down to risk aversion. While it can’t compete with the Dollar and Yen â€" its main safe haven rivals â€" in size and liquidity, it benefits from its perceived economic and fiscal stability, as well as through contradistinction with the surrounding Eurozone. In fact, the Franc’s rise against the Euro has been even steeper than its rise against the Dollar. As the Eurozone crisis radiates further away from Greece, Switzerland has come to seem more like an island in a sea of chaos.

Even an abatement in the EU storm has failed to produce a Swiss Franc correction. That could be because the bad news coming out of Europe seems to be never-ending; one country’s rescue is followed by the downgrade of another country’s sovereign credit rating and warning of imminent collapse. In addition, even as investors have embraced risk-taking, they still remain prone to sudden backtracking. Thus, the Franc has been one of the primary targets of risk-averse capital fleeing the Egyptian political turmoil.

Capital controls and intervention have scared investors away from some currencies, but the Swiss National Bank (SNB) lacks the credibility afforded to other Central Banks. The SNB lost $25 Billion in 2010 in a vain effort to hold down the Franc, and currency investors believe that it has neither the stomach nor the mandate to engage in a similar loss-making campaign in 2011. Besides, the Swiss economy has held up remarkably well, and the trade surplus has actually widened in the face of currency appreciation. The markets might be keen to test the limits of the Swiss export sector, in much the same way that they have challenged Japan by pushing up the Yen.

Still, their are limits to high the Franc can rise, and it appears that I’m no longer the only analyst who thinks it’s undervalued. Don’t forget- the Swiss economy is comparatively minuscule. Its capital markets can absorb only a small fraction of the inflows that the US and Japan can handle, and the Swiss Franc represents a mere 3.5% of all foreign exchange volume, 12 times less than the US Dollar’s share. In other words, it’s only a matter of time before investors run out of Swiss assets to buy, at which point they will have to decide whether to accept short-term returns of 0% in exchange for capital preservation and financial security. My bet is that they’ll walk.

Of course in the short-term, it’s possible that a handful of risk-averse investors will continue to steer capital towards Switzerland, and/or that another mini political or economic crisis will trigger a spike in risk-aversion. When investors once again look at fundamentals, they will be forced to reckon with the Franc’s 40% appreciation over the last five years, and probably conclude that perhaps it was a bit much…

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Who's Working?

« Tensions Flaring! | Home
By Mike Conlon | February 4, 2011
That is the question that will be answered later this morning as today is “jobs Friday� and we eagerly await the release of the Non-Farm Payrolls report and the unemployment number. This is one of the most important data releases as it shows whether or not meaningful jobs are being created. The expectation is for a gain of 140K jobs.
The unemployment rate is also due out and this can sometimes be a deceiving number as the participation rate will sometimes affect the overall numbers. A higher participation rate usually means that workers are less discouraged and looking to get back in the workforce. Our neighbors to the north, Canada will also be reporting their unemployment rate. As goes the US, so goes Canada. At least that has been the market action of late, as part of the fate of Canada’s economy lies with US economic recovery, for better or worse.
There is no other economic data due out for the rest of the day, so expect the markets to trade off of that NFP number.
The Aussie is higher as the RBA lifted both its economic and inflation forecasts despite the recent natural disasters and previous comments form the RBA head.
And lastly, the Euro zone head honchos are meeting today in Brussels for a debt summit where the hope is that they will produce some meaningful response and solution to how to deal with the crisis. Don’t count on it.
In the forex market:
Aussie (AUD): The Aussie is higher across the board as the RBA raised its GDP outlook for 2011 to 4.25% growth from a previous forecast of 3.75% and they raised their inflation outlook with CPI set to increase 3% from a previous forecast of 2.75%. If they are correct in the new assessment, then we will see further rate hikes in Australia some time this year unless another global crisis emerges. (Click chart to enlarge)

Kiwi (NZD): The Kiwi is mostly lower getting a bit of follow-thru from the negative employment report that came out on Wednesday night. In addition, money flows are potentially returning to the Aussie after the RBA raised its outlook.
Loonie (CAD): The Canadian employment report just came out and showed a gain of 69.2K jobs vs. an expectation of 15K, handily beating the estimate. The unemployment rate remained steady at 7.8%. (Click chart to enlarge)

Euro (EUR): The Euro is slightly positive ahead of the US NFP report and has been in a tight range holding just above 1.36. While there was no meaningful data out this morning, the debt summit could produce fireworks if the sides don’t move any closer to resolution.
Pound (GBP): The Pound is somewhat mixed as a reading of house prices showed a gain of .8% for last month vs. an expectation of a decline of .3%. While on reading does not make a trend, this does contribute to the overall sentiment that inflation is rising in the UK.
Dollar (USD): All eyes will be on the NFP report where the US economy is expected to add 140K jobs. The unemployment rate is expected to tick higher to 9.5%, though that may be a function of the participation rate scenario that I mentioned above. Back in the day on the trading desk, we used to wager on the number so I will proffer my guess. My feeling is that the economic data has been too rosy of late so I think the number may disappoint. So I’m calling for a gain of 94K. Note: this is not a trading recommendation or advice, but rather a guess.
Yen (JPY): The Yen is slightly lower as Asian markets were higher overnight and it really is just puttering around waiting for the NFP number. A better than expected number will likely encourage some Yen selling and risk-taking through carry trades, and a worse than expected number could induce Yen strength as a safe haven going into the weekend with Egypt situation still unresolved.
Today’s NFP report really serves as a barometer for the economy and this is one of the reasons why it is so closely watched. While the economic data of late has been better than expected, my intuition always tells me that when expectations are high, they sometimes disappoint.
I am not trying to be Debbie downer here, its just that I think that while the economy is recovering, I don’t think it is happening as fast as people would like to believe. If I’m wrong, I’ll be more than happy to admit as much.
But realize that just because I have a certain view, doesn’t mean that I am married to it and as a trader I will perfectly happy to throw that view aside and join the trade to go the other way.
I also wanted to mention the situation in Egypt, which is still uncertain as to what the likely outcome is going to be. So we could see some selling later in the day and Dollar strength as the flight to safety trade picks up ahead of the weekend.
So be careful around the NFP number as the volatility will be intense. And trade well!
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