Euro Danger!

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By Mike Conlon | May 10, 2011

Where there’s smoke, there is fire and it is no different for the Greece and the Euro zone. The stories that are being floated insinuate everything from Greece leaving the Euro zone, restructuring debt, or receiving further bailouts. At this point it is difficult to determine what is actually going to happen, but one thing is clear: Greece is in need of help.

Yesterday S&P poured gasoline on the fire and downgraded Greece’s credit rating again, and the current rates Greece would have to pay to re-finance are not feasible in the market. So there is heightened structural risk for the single currency.

In the UK, retail sales figures came in better than expected, but the market is looking ahead to tomorrow’s GDP estimate, which is likely to set the bar low so that the BOE can act surprised when it comes in “better than expected”.

China’s trade balance figures came in better than expected with better exports and worse imports. If they cared to have a stronger Yuan as I mentioned yesterday, perhaps they would be willing to buy more of other people’s stuff. Chinese CPI data is due out tomorrow and there is an expectation that they will raise rates again to try to slow growth.

Oil prices are lower to start the day, as the CME raised margin requirements for oil, but stocks and other commodities are trading higher.

In the forex market:

Aussie (AUD): The Aussie is mixed despite better than expected trade balance figures as the potential for a Chinese slowdown could affect Australia greatly.

Kiwi (NZD): The Kiwi is mostly lower after the IMF came out and said that the Kiwi was over-valued by roughly 20%. Thanks guys! (Click chart to enlarge)

Loonie (CAD): The Loonie is mostly higher today despite lower oil prices as the soundness of the Canadian economy is has been highlighted today after last week’s elections which the market perceives as adding to fiscal responsibility.

Euro (EUR): With all that is going on with Greece, it’s easy to lose sight of the fundamental data that still exists. Tomorrow will bring CPI data and Friday will be the GDP report. The Swiss franc is lower today as CPI data came in less than expected.

Pound (GBP): The Pound is mostly lower as the market is expecting tomorrow’s GDP estimates to be reduced, despite today’s better than expected retail sales figures which showed a gain of 5.2% vs. an expectation of 2.5%. How much longer the UK can deny better than expected data is anyone’s guess. (Click chart to enlarge)

Dollar (USD): The Dollar is showing some strength today despite higher stocks and commodities (except oil) prices as there is still some risk from the Euro zone pushing the safe-haven play.

Yen (JPY): The Yen is lower across the board as the Nikkei was higher on better than expected stock earnings which out-weighed Euro debt concerns.

While there is certainly a great deal of risk in the marketplace emanating from Greece and the Euro zone, the market doesn’t seem to be overly concerned about it. While everyone expects some sort of resolution to be forthcoming, the way in which it is handled could have a major impact.

As I mentioned above, there are many different competing financial interests that could be affected by different outcomes, and the ECB should have come up with a credible plan for Greece (and the others) long ago, as no one expected these problems to just disappear.

But without them we would have little to talk about so the outcome will be important going forward. But I don’t expect Greece to leave the Euro zone, nor do I expect to see a major restructuring of debt. What is most likely is that Germany will reluctantly agree to further aid, and the IMF will get Greece more favorable terms.

However until this occurs, it is wise to be cautious.

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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EURO to Survive a Greek Haircut?

As expected, the Greek tragedy dominates the markets. It’s a long performance with no intermissions. The rumors of another Greek bailout package (EUR+60b), to come into force next month, is providing a ray of hope for risk investors.

Credit markets are in corrective mode this morning, with broad tightening across the curve. The indices have nearly reversed all the Greek inspired widening since yesterday. The EUR is also getting a lift from Bin Smaghi’s comments that a debt restructuring (code name for default) would cause more problems than it solves. It’s so true, European banks would have to finally clean their balance sheets to withstand a genuine Greek ‘haircut’ and the market believe they are in no position to withstand this scrutiny. The problem is that Greece needs growth in its tax revenue to finance all this and that’s not easily forth coming.

This months 6-month Greek T-bill auction has also attracted a healthy demand this morning. The sovereign was able to offload +1.625b at a yield below the psychological +5% (+4.88%) with a bid-to-cover ratio of 3.58.

The US$ is stronger in the O/N trading session. Currently, it is higher against 11 of the 16 most actively traded currencies in an ‘subdued’ session.

The USD is lower against the EUR +0.07% and higher against GBP -0.13%, CHF -0.49% and JPY -0.44%. The commodity currencies are weaker this morning, CAD -0.04% and AUD -0.06%.

After three consecutive months of gains, Canadian housing stats declined at a faster pace than expected last month (-3.2%). Most of the weakness was focused in multi-starts (-5.1%) as singles rebounded. This would suggest that the drag on growth for April will likely be more modest than the headline suggests, couple with S&P’s cutting their rating for Greece has temporarily dampened some of the investor demand for riskier assets. The loonie has been able to pare some of yesterdays losses on the back of a tepid rise in commodities after the over extended price movement last week.

Last week, the CAD retreated from a three-year high as commodities plunged on concerns for Greece’s continued Euro membership, pushing investors to seek temporary sanctuary in the world’s go to safe heaven currency, the dollar, and this despite another stellar jobs report north of the forty-ninth parallel (+58k and +7.6%). With corporate CAD buying interest not appearing until above 0.97, the loonie remains at the mercy of energy prices. If one eliminates all the noise, investors wish to be better buyers of the currency on dollar rallies (0.9623).

The global commodity boom is supporting the Australian trade surplus. Data this morning shows that the trade balance rose to a +1.7b surplus in March from a downwardly revised-87m deficit in February. Increased exports of iron ore (+30%, m/m) and coal (+27%) is driving the +9.2%, m/m rise in total exports, outpacing the +1.2%, m/m rise in imports. The recent commodity boom is leading to an increase in both the price of and demand for hard commodities and the Aussie dollar outright. Stronger Chinese trade data O/N (+$11.4b), a sign that tighter monetary policy is ‘not crimping the Asian nation’s growth’ is also a plus for Australia economy.

The currency has been able to rebound from last weeks lows after the RBA sounded ‘surprisingly’ hawkish in its Statement of Monetary Policy. The hawkish Statement came in well above market expectations of forecasts remaining unchanged. Governor Stevens is signaling that ‘current mildly restrictive monetary policy is not enough to contain inflation pressures in the pipeline’. Furthermore, the RBA is indicating that market pricing of one hike over the next year is not enough. Underlying inflation is now expected to be above its 2-3% target band by the end 2013.

Aussie yields are still the highest in the G10 and do look attractive. The expected mix of trade surpluses and rising capital inflows should provide support for the currency on pullbacks for the time being (1.0788).

Crude is lower in the O/N session ($101.52 -$1.03c). Oil prices rebounded yesterday from the plummeting nature of last weeks actions, on signs that global economic recovery remains intact. Market participants believe that the recent purging in most asset classes is somewhat overdone and that we are experiencing a technical rebound after last weeks-15% haircut, the biggest drop in three-years. The market will be weary of this weeks inventory report, expecting another build in inventories.

Not helping the black-stuff was last week’s EIA report, which was much more bearish than expected. The data showed crude stocks rising +3.4m barrels greater than the +2m barrel build expected by the street, signaling less demand from refiners. On the flip side, gas stockpiles fell-1m barrels, while inventories of distillates (heating oil and diesel), fell -1.4m. Analysts had expected that gas stocks would rise +100k barrels. They were looking for distillate stocks to climb +400k. Gas consumption dropped -2.2% to +8.94m barrels a day last week.

Higher oil prices have been denting demand growth and it’s this drop-off, combined with the overall retreat in commodities, and a rising dollar that forced this drastic easing of oil prices this month. The market had been overbought and last week’s purging is largely a momentum thing. Expect the energy market to find more support below these current levels.

Gold has rebounded as investors take advantage of last week’s free fall in prices to enter the market. The uncertain macro-economic and political environment has encouraged investors to want to own their piece of gold. The yellow metal, as a non-yielding asset, has a higher opportunity cost when interest rates rise. Big picture, the commodity has become the currency of choice because of the heightened currency volatility and on the back of a questionable dollar value.

The metals bull-run is far from over with speculators continuing to look to buy the metal on these deeper pullbacks, however, with inflation expectations dipping this month has the weaker ‘long’s’ remaining on the back foot and second guessing their outright positions ($1,515 +$12.10c).

The Nikkei closed at 9,818 up+24. The DAX index in Europe was at 7,480 up+70; the FTSE (UK) currently is 5,993 up+51. The early call for the open of key US indices is higher. The US 10-year eased 1bp yesterday (3.16%) and is little changed in the O/N session.

Treasuries prices are caught in a tug-of-war as they trade within striking distance of their lowest yields this year. European growth and debt concerns has investors reducing some of their risk appetite, while the issuance of $72b’s worth of product this week and the belief that US retail sales will surprise is trying to push yields higher.

The US treasury plans to sell $72b of long-term debt this week, starting with today’s auction of $32b-3, tomorrow’s $24b-10’s and Thursday’s $16b long-bonds. At the moment they certainly appear rich on the curve, expect dealers to try to cheapen that curve.

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What the Forex Markets Tell Us about Gold & Silver

All investors, regardless of stripe, must now be aware both of the bull market for gold/silver and the bear market in the US dollar. Despite all of the rhetoric, however, it seems that little is actually understood about how these two phenomena are actually connected. Ultimately, this connection (or lack thereof) has serious implications for both markets.

Many gold investors insist they are buying gold as a proxy for shorting the dollar. Commentary on gold prices is full of apocalyptic warnings about the current financial system and criticism of fiat currencies, which are backed by nothing except for good faith. They argue that buying gold is the best (or even the only) hedge against the eventual collapse of the dollar.

Unfortunately, I don’t think this argument holds up to close scrutiny. First of all, gold and silver [I am including silver in this analysis not because of any deep relationship to gold, but only because of the association ascribed by other commentators and an observable market correlation] prices have risen much faster over the last year (and decade, for that matter) than even the strongest currencies. Furthermore, gold is rising faster than the dollar is falling. In terms of the Swiss Franc â€" which is to forex markets as gold is to commodities markets â€" gold has risen more than 17% since the start of 2010.

Second, the putative correlation between gold and forex markets asserts itself sparingly (as you can see from the chart below, which plots gold against an index that shows dollar bearishness), and in difficult-to-understand ways. For example, gold stalled during the financial crisis, while the price of silver suffered a veritable collapse. Does it make sense that when financial anxiety was highest, interest in gold and silver ebbed? Along similar lines, the recent rally in the dollar followed the recent correction in gold and silver â€" NOT the other way around. If anything, this shows that gold investors are taking their cues from the broader commodity markets, and not from forex markets.

Third, the macroeconomic case for gold is flimsy. While I don’t think it’s fair to attack gold on political grounds, I still think it’s reasonable to try to ascertain what forces are supposedly being hedged against. If it is inflation that gold buyers are worried about, why aren’t other all investors equally concerned? Based on futures markets â€" whose credibility is just as solid as gold markets â€" inflation expectations are around 2-4% across the G7. If instead it is sovereign debt default that gold investors are concerned about, again, I have to ask why other markets don’t share their concerns. Credit default swap rates are higher for Japanese and European debt than for US Treasury securities, but the yen and euro remain positively buoyant against the dollar. Again, how do gold investors explain this contradiction?

To me, it seems obvious that gold and silver are rising for reasons that have very little to do with fundamentals. Monetary expansion has driven a wave of money into financial markets, and a significant portion of this has no doubt found its way into gold, silver, and other metals. In fact, it seems that last week’s correction was driven partly by higher margin requirements for speculators. Finally, their cause is being helped by low interest rates, since the opportunity cost of holding gold (which doesn’t pay interest) in lieu of dollars (which does) is currently close to zero. When interest rates rise, it will certainly be interesting to see if there is any impact on gold.

In the end, I don’t have a strong understanding of gold and silver markets. For all I know, their rise is genuinely rooted in supply/demand, as it should be. My only wish is that investors will stop pretending that it has anything to do with the dollar.

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Introduction to Technical Analysis: Morning Fake-out

© 2004 - 2011 Forex Blog.org. Currency charts © their sources. While we aim to analyze and try to forceast the forex markets, none of what we publish should be taken as personalized investment advice. Forex exchange rates depend on many factors like monetary policy, currency inflation, and geo-political risks that may not be forseen. Forex trading & investing involves a significant risk of loss.

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Commodities Collapse!

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By Mike Conlon | May 6, 2011

As we all know by now, the inputs that make up the global economy are all inter-twined and that’s what makes the forex market so interesting. Yesterday, commodities prices collapsed across the board, bringing down prices in oil, precious metals, and even agricultural products. Oil is now under $100, gold under $1500, and silver back to under $35.

This begs the question as to what is actually driving prices higher, and what caused this sudden decline. While I think declining commodity prices are a good thing as this can relieve headline inflation, the role of speculators, the US Fed and other Central banks, and supply and demand dynamics must all be examined.

But there was an interesting confluence events occurred yesterday which is likely the reasoning for such a sell-off. While in the US we had a dismal initial jobless claims numbers, the ECB rate policy statement did not confirm that further rate hikes would be coming and deferred to the flexibility the ECB has. The market took this as dovish and began selling Euros, which helped the Dollar rally the most in nearly 2 years.

So adding it all up, we have weakening global economic data, potential pauses in rate hikes abroad which cause Dollar strength, the end of QE2, and the Non-Farm Payrolls report later this morning which all could support a strong Dollar position. However, at this point we can’t rule out further Fed easing if the data continues to get worse here in the US.

So what we’ve been waiting for all week, the US Non-Farm Payrolls Report is expected a gain of 185K jobs.

In the forex market:

Aussie (AUD): The Aussie is mostly higher despite lower commodity prices to start the day as the yield differentials are just too hard to ignore.

Kiwi (NZD): The Kiwi is also higher for the same reasons as the Aussie.

Loonie (CAD): The Loonie is mostly higher as a better than expected employment report shows that there is economic improvement in Canada. Canada added 58.3K jobs vs. an expectation of 20K, and the unemployment rate ticked lower to 7.6% from 7.7%. (Click chart to enlarge)

Euro (EUR): The Euro is mostly lower after the market perception over the ECB statement yesterday is that there may be a pause in rate hikes. The Euro is improving this morning after the NFP figure was released. (Click chart to enlarge)

Pound (GBP): The Pound is mixed as “mum is the word” out of the BOE yesterday. By not issuing a policy statement yesterday, the Pound should continue to strengthen vs. Euro.

Dollar (USD): Wow again. NFP came in showing a gain of 244K jobs, which was much better than the expected 185K and quite a shock to the market. The one negative is that the unemployment rate moved higher to 9% from 8.8%, though it is uncertain what is driving that number.

Yen (JPY): The Yen is weaker across the board as it appears to be “risk-on” again in Japan after yesterday’s holiday.

It looks like some of the correlations that the markets rely on may be breaking down a bit as it appears as though the market is not sure what to make of the data.

On the one hand, good economic data here in the US means that Bernanke and the Fed could let QE2 expire without having to take further monetary action, which should strengthen the Dollar as it has been kept unusually low thanks to that policy.

But on the other hand, good economic data also means that the US economy is recovering, which could put the risk trade back on again, which would mean selling Dollars and buying commodities and higher yielding currencies.

Right now oil is still trading lower, the Euro has just gone positive vs. USD as it is weakening across the board. Stock markets are flying higher, so at this point it looks like the risk appetite is out-weighing the thought that the end of QE2 could bring Dollar strength.

I expect to see some volatility over the ensuing trading days as the market works this all out!

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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Forex Week in Review: May 1-6

It was a week many would like to forget. A week of surreal price movements across all asset classes. The perfect storm of price movement, with investors exiting the one directional, inflation premium commodity trade with gusto, after the CME cost hiking, the rumors of a Soros fund exiting ‘the’ trade and a less hawkish Trichet omitting the code words ‘most vigilant’ from his communique. Now the market has to endure European finance officials in Luxembourg for an unscheduled meeting as rumors of Greece possibly wanting to leave the Euro zone has market sentiment remaining on the defense at week’s end. Below are some of the highlights of the week:

EUROPE

• Euro area manufacturing PMI data for April was revised higher from 57.7 to 58.0, above expectations set for a flat 57.7 reading. The data is consistent with strong growth and provides a comforting outlook on the sector, especially in the light of the stagnant recent Ifo reading.
• Swiss SVME PMI indicator fell unexpectedly to 58.4 from 59.3 last month, while markets were looking for a 59.8 reading.
• Swedish PMI surprised to the upside in April, rising from 58.6 to 59.8 m/m with consensus set at 58.5.
• Unlike Norway who had a sharp downward PMI revision, as the headline fell to 55.6 from 57.4.
• UK manufacturing PMI badly disappointed with a drop to 54.6, the lowest level since last September. The market expected a 57.0 print and, to make matters worse, the March reading was revised down from 57.1 to 56.7. With a weak domestic orders component, does not bode well for growth momentum going into second quarter.
• In Sweden, the Riksbank’s minutes confirmed the very hawkish stand of the executive board.
• Portuguese/German 10-year spreads have tightened on news of agreement on an aid package between the Portuguese caretaker government and EU institutions. The deal still has to be approved by the Portuguese opposition and the EU governments.
• The Euro-zone services PMI was revised down slightly to 56.7 from the preliminary 56.9, coupled with the upward revision to manufacturing PMI, leaves the indicator on firm footing.
• UK construction PMI came in at 53.3, well below the 55.9 expected. Money supply data remained soft, the preferred measure of money supply for the MPC, the three-month annualized rate of M4 ex-intermediate OFCs eased to +1.0% from +1.7% in February.
• UK services dropped to 54.3 in April from 57.1 in March, well below the 56 consensus forecast. With all UK PMI surveys (manufacturing, construction and services) sharply lower this week points to sluggish growth entering the second quarter. This should keep the BoE dovish.
• German factory orders surprised the market with a sharp drop of -4% m/m in March with February print revised lower to +1.9% from +2.4% previously and pushed the annual growth rate to only +9.7% y/y, down from 19.6% in February.
• German industrial production beat expectations rising +0.7%, m/m vs. +0.5%.
• UK PPI printed higher than expected, with the output PPI rising +5.3%, y/y last month vs. +5.1% forecasted. Perhaps higher commodity prices might be starting to filter through.
• Both the BoE and the ECB held rates steady at +0.5% and +1.25% respectively. Trichet’s well documented less hawkish tone had the market pricing out near term inflation premium.
• In Norway, manufacturing production printed stronger than expected at +0.9%, m/m, vs. expected +0.6%. The annual rate accelerated to +3.0%, y/y from +2.0% in February.

Americas

• In Canada, Prime Minister Harpers Conservatives won a ‘majority’. To date, the Tories have pursued policies that have been fairly friendly to the CAD.
• US Treasury Secretary Geithner reiterated that global economies would benefit if China allowed its ‘substantially undervalued’ currency to strengthen. Expect more rhetoric to seek the appreciation of the Yuan ahead of the US-China Strategic Economic Dialogue next week.
• US manufacturing slowed last month (60.4), but not as much as expected (59.5). However, rising costs remain a problem (85.5). The ISM report contrasts the Fed’s regional surveys which show that manufacturing expanded in April. Manufactures continue to experience significant cost pressures from commodities.
• US factory orders climbed for a fifth consecutive month in March (+3%). A broad based increase in orders as well as rising prices for food and oil were factors behind the bigger than expected gain.
• US ADP’s estimate of +179k for private non-farm payroll growth fell short of market expectations (+200k). On the plus side, March data was revised higher by +6k to show a gain of +207k jobs.
• The much weaker than expected US ISM non-manufacturing data has given the investor another reason to be concerned about the US economy and further justifying the Fed’s ‘extended’ monetary policy. The ISM plunged 4.5 points to 52.8 in April, well below expectations (57.4).
• US weekly initial claims jumped to +474k, up from the previous weeks +431k. As long as the headline number stays above +400k, this would imply a slower recovery than the Fed would like.
• US Non-farm productivity rose at a +1.6% rate in the first quarter, beating the streets estimate of +1.1%. The preliminary estimate of hourly compensation (+2.7%) was half-a-percentage point higher, boosting the estimated growth rate of unit-labor costs to +1.0% versus a decline of 1.0% in the fourth quarter.
• Canadian Ivey PMI came out at 57.8, unadjusted 57.7, plummeting from 73.3 last month, has added some pressure to the ‘risk off’ tone mid-week.
• March’s Canadian building permits came in much stronger than expected, with a massive +17.2% increase after a strong +9.8% gain in February.
• NFP expanded by +244k last month, the biggest gain in a year, after a revised +221kincrease the prior month. The jobless rate climbed to +9% (first increase since November).
• Canadian employers added a net +58.3k jobs in April after a decrease of -1.5k in the previous month. The jobless rate unexpectedly dropped to +7.6%.

ASIA

• China’s April PMI fell -0.5 points to 52.9 with new orders falling -1.4 points to 53.8. Some proof that China’s economy is decelerating amid rising financial stress for non state owned companies, wide spread labor shortages, and emerging power interruptions. Does the weaker data curtail policy tightening?
• As expected, the RBA left their rate policy on hold (+4.75%). Their following communiqué was hawkish compared to the April release, but certainly caught the rate’s market on the back foot, who had pushed yields higher going into the meeting in the wake of higher than expected first quarter inflation. Governor Stevens’s communiqué ran a balanced mix of downplaying first quarter inflation due to the floods, noting strength in the labor market and a pickup in corporate credit growth but weakness in household credit. However, he went on to say that ‘the marked decline in underlying inflation from the peak in 2008 has now run its course.
• The Reserve Bank of India hiked policy rates +50bps to +7.25% and +6.25%, respectively on the repo and reverse-repo, more than the consensus forecast for +25bps.
• New Zealand building permits rose only +2.2% m/m in March after the sharp fall of -9.8% m/m in February.
• Japan Finance Minister Noda went out of his way this week to distinguish the current yen movement from the pre-intervention period. He noted that the moves stem from weakness in the dollar, not from yen strength.
• New Zealand reported a higher than expected +1.4% q/q rise in employment in the first quarter.
• Australian retail sales were weak in March, down -0.5% m/m vs. an expected +0.5% gain.
• The RBA’s Monetary Policy Statement also emphasized the possibility for further policy divergence. The statement came in more hawkish than market expectations of forecasts remaining unchanged. Policy makers indicated that market pricing of one hike over the year ahead (to May 2012) is not enough. Inflation is expected to be above its +2-3% target band by end 2013.

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Where Rubber Meets The Road!

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By Mike Conlon | March 4, 2011

All eyes this morning are on the US Non-Farm Payrolls (NFP) report due out at 8:30AM EST. While this is always one of the most significant economic reports that will induce market volatility, it hasn’t been this anticipated for some time.

Last month’s NFP report was an outlier, in that the 36K jobs gains reported almost came with a notion of disbelief, as if it was a mistake of some sort. Bad weather was blamed for the disconnect; but the figure showed that only 36K jobs were created, yet the unemployment rate fell from 9.4% to 9%. As I said in last month’s NFP blog article, you can’t have the BLS without the BS!

So this month we are expecting there to be gains of 196K jobs, with the unemployment rate ticking slightly higher to 9.1%. Recent data of late has been better than expected, especially when considering that the ADP employment change showed better than expected gains on Wednesday, and initial jobless claims came in lower than expected on Thursday. “Only” 368K people lost jobs last week, beating the expectation of 395K losses.

So this number should be pretty good today then, right? I’m not so sure. As I mentioned last month, when everyone gets their hopes up so high for good numbers, they usually end up disappointed. There is no other news to rely on today, so this number will be critical.

Last month I offered a guess as to what the number would be, and will my prediction was correct that it was worse than expected, I couldn’t imagine how much worse it was. This month I think we may see more of the same. So my prediction (remember this is a guess and NOT a trade recommendation) is that we will see jobs gains of 112K, better than last month but missing expectations. I think this will somehow induce US dollar strength today, as the Dollar seems very oversold to me. Regardless of what happens, there will be major volatility as the market digests the data.

Speaking of volatility, who saw the crazy move on the Euro yesterday? It happened right around 8:30 and the talking heads tried to attribute it to the initial jobless claims numbers, but basically ECB head Trichet said that he could raise rates next month, sending the Euro higher to the tune of 150 pips. This also helped risk-taking as US stocks made tremendous gains.

Stocks and commodities are higher to start the morning, but will these gains continue? Stay tuned for NFP!

In the forex market:

Aussie (AUD): The Aussie is mostly lower this morning as Prime Minister Gillard said that Aussie strength “puts burdens” on some areas of the economy. In addition, a separate report cited Australia’s housing market as being in a tremendous bubble which could pose a risk to the economy.

Kiwi (NZD): The Kiwi is also lower as the International Monetary Fund (IMF) said it will likely cut it forecast of New Zealand’s growth as a result of the two earthquakes. The rate expectations for New Zealand actually show that a reduction may be coming before another hike. The Kiwi has had a tough week. (Click char to enlarge)

Loonie (CAD): The Loonie is mixed this morning as the tug of war between higher oil prices and Canada’s economic ties to the US battle for position.

Euro (EUR): Wow, what a move for the Euro yesterday. The ECB finally did issue the hawkish comments the market was waiting for, after about 45 minutes of hemming and hawing. Was that a timed announcement with US economic data at exactly 8:30AM? Let the conspiracy chatter begin! (Click chart to enlarge)

Pound (GBP): The Pound is mostly higher as rate expectations shrug off recent home price data that has showed declines.

Dollar (USD): The Dollar is actually trading higher this morning as despite the mild risk taking in the market: This “wait and see” approach should provide trading opportunities on the release of the NFP report.

Yen (JPY): The Yen is weaker across the board as it is still trading under expected risk themes.

Put up or shut up! There are no more excuses! The US needs to see jobs growth and today’s number will be critical. There are two competing arguments for the direction of the Dollar today.

The first argument says that if the number should come in better than expected, then the Dollar should rally higher as this means that the US economy is improving and Bernanke will have to move on rates sooner to combat inflation. If the number is worse, than it justifies his position of fragile recovery and the need for a weak Dollar.

The alternate argument is that a better than expected number while good for the economy, will cause Dollar weakness as Bernanke has been blind to the inflation story and will not pre-empt QE2 under any circumstance. This comes as just about everyone else around the globe is complaining about inflation.

I’m actually in the second the camp, but think that a worse than expected number will cause Dollar strength today (the opposite of the scenario I laid out above). However, I will not be taking positions before the release, as I always prefer to let the market tell me which way to go.

So I can envision a scenario where the number comes in worse than expected (see my guess above) and initially the Dollar trades lower, but then quickly rebounds and finishes the day higher. This feels like a “crescendo moment”, with a sharp price spike and major volatility to reverse recent Dollar weakness.

At least that’s what I hope will happen, otherwise the Dollar may be falling off of a cliff! See you at 8:30!

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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Week in Review-March 4th

The EUR continues to outperform the dollar as investors interpret the ECB’s view to oil price shocks as inflationary events requiring a tighter monetary policy, in contrast to the Fed and the BOE, who are focusing on the deflationary impact. Trichet has followed in the hawkish footsteps of his coworkers and plied the EUR with enough ammo to dominate the non-inflationary Bernanke effect. The ECB will take the fight to inflation, maybe as early as next month. With the Libyan situation showing little signs of improvement and with the sovereigns continuing to weigh on the dollar, safe heaven trading strategies are the only option in this current environment. Below, we have some of the highlights of the week.

EUROPE

• Fine Gael wins Irish election and is in coalition talks with Labour. Victory will give them a clear mandate to try to renegotiate its EU/IMF bailout package.

• Euro area January CPI was revised down to + 2.3%, y/y from flash estimate. Core-CPI was also a tenth below consensus. Market continues to see elevated risks of a hawkish shift from the ECB.

• Euro manufacturing PMI’s continued to surprise to the upside, with particular strength in Ireland and Italy, driven by the forward looking components. Greece remained the weak spot amongst the periphery. Euro area was left unchanged at 59.

• Swiss PMI and 4th Q GDP showed surprised strength. GDP grew +0.9%, q/q, while the PMI bounced to 63.5 (highest level in six-months). Strong external demand from Germany and Asia is pulling the economy along despite CHF overvaluation. No hawkish rhetoric is expected at this months SNB meeting.

• UK PMI was flat last month, 61.5. New orders moderated, but employment hit a fresh high of 61.7 from 59. The 2011 releases show a solid recovery in the UK manufacturing sector in 1st Q and supports the hawkish camp at the MPC. King continues to send distinctly dovish signals that ‘raising rates to make a gesture is self defeating’. Market is pricing a hike in May.

• UK services PMI fell to 52.6 from 54.5, m/m. Analysts view the softness as more of a technical reversion to trend after the weather-induced volatility in December and January.

• Euro-zone registered strong increases in services (56.8) and composite PMI’s (58.2) for February, but below the preliminary estimates. Strong services gains were driven by France and Italy. The peripheries saw substantial gains in Ireland and Spain. Services PMI’s coupled with the firm manufacturing PMI’s point to robust growth in the Euro region.

Americas

• US consumers are hoarding their stimulus. Consumer spending disappointed with a +0.2% gain. Offsetting this disappointment is income jumping +1%, more than double the expected pace.

• Strong proof for the US housing markets weakness was pending home sales falling for a second consecutive month in January (-2.8% to 88.9). Even the revisions went deeper, with December falling into negative territory (-3.2%) from its original positive print (+2%).

• February’s Chicago PMI print of 71.2 was the highest reading in 23-years, led by a surge in production to 78.2 from 73.7. This release is hot on the heels from the January ISM manufacturing index, and the Empire and Philly Fed surveys for February and providing more proof that manufacturing is picking up in the 1st Q, in part on a need to build inventories.

• Surprisingly strong Canadian 4th Q GDP of +3.3% vs. +3% expected and an upward revision to the 3rd Q print to +1.8% from +1% pushed the loonie to new three years high outright.

• US January ISM numbers expanded at its fastest pace in seven-years (61.4 vs. 60.8), as factories added workers and pumped up production, continuing the momentum for their expansion.

• US construction spending fell for a second-consecutive month in January (-0.7% vs. -1.6%). Builders have had trouble getting finance and even with the tighter credit conditions, demand for credit in some places remains weak.

• Bernanke will not be tightening monetary policy until he is more confident that US recovery can stand on its own. ‘Once we see the economy is in a self sustaining recovery and employment is beginning to improve and labor markets are improving and inflation is stable and approaching +2% or so….at that point we will begin withdrawing’. That being said, he is aware of the risk that the Fed will act too slowly and allow inflation to get controlled.

• The BoC held rates steady at +1%. Governor Carney expressed his concern about the strength of the loonie ‘the export sector continues to face considerable challenges from the effects of the persistent strength in the Canadian dollar and Canada’s poor relative productivity performance’. The new reality is a Canadian dollar at or close to parity as the economy adjusts to this paradigm.

• ADP Private Payrolls rose +217k last month, up from a revised +189k.

• Fed’s Beige Book suggests that overall ‘economic activity continued to expand at a modest to moderate pace in January and early February’ and that price pressures are increasing. All the districts recorded ‘solid’ growth in manufacturing and retail sales increased in all districts.

• US weekly claims fell by -20k to +368k, the lowest level in nearly two-years. The less volatile four-week-moving-average now stands at +388k.

• US ISM non-manufacturing was not much of a surprise, coming in at 59.7 last month, just above market expectations. However, it’s the strongest reading since August 2005. The headline print is proof that the service growth appears to be finally entering a ‘self-sustaining’ pattern.

• US job market rebounded last month, unemployment rate fell to 8.9%, lowest level in two-years. NFP rose +192k as private sector added +222k new jobs. The January number was revised to show an increase of +63k from a previous estimate of +36k. The Fed still expects unemployment to range from +7.5% to +8% at the end of 2012 as the economy only slowly regains the 8.75m jobs lost.

• US January factory orders reported a strong +3.1% increase. The mixed data (strong non-durables and weak durables) remains consistent with strength in the above manufacturing surveys.

• Canadian Ivey PMY continues to express extreme volatility rising to 69.3 last month from 41.4 in January. The correlation between PMI and total remains weak. Market perhaps should be looking at a six-month average.

ASIA

• NZD Confidence rose to 34.5 last month â€" a seven-month high â€" from 29.5 in January.

• Japan industrial output rose a weaker-than-expected +2.4%, m/m (+4% expected). Retail sales (seasonally adjusted) rose +4.1%, m/m, vs. +2.7%. Manufacturing PMI rose for the fourth-consecutive month to 52.9 in February, with the new orders and export orders again rising significantly. JPY remains very much a play on the US rate outlook and risk aversion trading strategies.

• Chinese PMI data provided little excitement and little new information. Headline was in line with expectations at 52.2 in January. Analysts are calling for growth moderation and do not expect a change in monetary policy from Beijing any time soon.

• Dovish comments from New Zealand’s PM Key this week. He said that a RBNZ rate cut priced in by markets for March was in line with his expectations given the economic impact of the recent Christchurch earthquake. Market is pricing a 25bp RBNZ cut on the 10th March.

• Australian 4th Q GDP was weaker than expected +2.7%, y/y vs. +2.8%. The data still point to higher policy rates and AUD appreciation medium term. Analysts continue to anticipate a strong positive uplift this quarter despite severe flooding and cyclones. The RBA noted that mildly restrictive rates are appropriate. Do not expect them to get too far ahead of the RBNZ.

• Australia reported a -15.9%, m/m, fall in building approvals in January. Market continues to look beyond January data severely impacted by the floods.

• China’s non-manufacturing PMI fell to 44.1 last month from 56.4 and inline with seasonal patterns. The PBoC hiking 1-year lending, deposit rates +25bp and reserve requirement +50bp in February has also weighed on consumer sentiment.

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Oil Prices and the FX Conundrum

I haven’t blogged about oil prices in quite some time. After prices collapsed in the wake of the financial crisis, there really wasn’t much to talk about. However, the price of crude oil has risen more than 50% since June, and it now seems to be at the forefront of investor consciousness. Currency market watchers, in particular, need to brace themselves for the nuanced and sometimes contradictory ways in which oil prices bear on exchange rates.

Under normal conditions, the impact of rising oil prices on the currency markets is somewhat straightforward. First of all, the currencies of oil-exporting countries will typically experience some degree of appreciation. In addition, since oil contracts are still mainly settled in US Dollars, oil prices and a weak Dollar tend to go hand-in-hand. Second, insofar as rising prices drive inflation, the same can be said for Central Banks that are proactive in tightening monetary policy. As real interest rate differentials widen, (risk-averse) capital will naturally gravitate towards the highest returns.

The same logic cannot be applied to the current situation, however. That’s because this time around, oil prices aren’t being driven by economic fundamentals and rising demand, but rather by concerns over supply. You don’t have to be an expert to understand the connection between the continuing Mid East political crisis and oil futures. In the last two weeks alone, prices have risen a whopping 15% and show no sign of abating, as long as tensions linger unresolved.

From that standpoint, you might expect the political tensions to drive safe haven flows to the US Dollar. On the other hand, you would also expect that the resulting high oil prices might crimp the US economic recovery, and cause traders to punish the Dollar. However, you also need to consider that rising oil prices might also cause the Fed to eventually raise interest rates, or at least rein in QE2, which would be Dollar-positive.

Enough with the theory; let’s look at what’s happening in reality! The Canadian Dollar and Australian Dollar are rising, even though oil accounts for only 7% of the  former’s exports, and is a nil factor in the latter’s economy. It looks like forex investors are confusing oil prices with commodity prices, which are also rising, but at a much slower pace. In addition, since higher energy prices will probably erode economic growth in energy importing countries, this could actually hurt some commodity currencies over the long run.

The US Dollar has fallen across-the-board. While Ben Bernanke has insisted that the impact of higher energy prices on the US economy will be minimal, the markets are either taking the opposite view or are punishing the Dollar for the Fed’s dovishness. In other words, if Bernanke isn’t concerned about oil, he probably won’t cap QE2, and certainly won’t steer any interest rate hikes in the near-term.

Meanwhile, the European Central Bank (ECB), whose mandate is tilted towards maintaining price stability, has begun to voice concerns about the impact of rising commodity prices on inflation. Consumer and producer price indexes are rising across the Eurozone, and members of the ECB have suggested that they will take a proactive stance in preventing them from spurring inflation.

In conclusion, while both the EU and the US are net oil importers, the Euro is poised to outperform the Dollar, all else being equal. In addition, as long as the mid east political protests don’t drive further instability and contribute to any major supply shocks (especially in Saudi Arabia and Iran), there won’t be any impetus towards safe-haven capital flows. At the same time, while I don’t pretend to be an expert on oil prices, I would expect prices to stabilize and for a handful of minor corrections to materialize in the fx market. Traders are still looking for an excuse to short the Dollar in favor of, well, everything else, but sooner or later they will have to accept the limits of this trade, high oil prices or not.

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EU Ponders Tobin Tax

Only two years after the worst financial crisis in decades, the DJIA is now back above 12,000. Yield-hungry investors are pouring record amounts of cash into emerging markets. Commodities and food prices are rising into bubble territory. In fact, not a single meaningful reform has yet to be passed that would prevent such an event from erupting again. The EU, however, is trying to change that, with the proposed introduction of the first-ever Tobin tax on foreign exchange trades.

The campaign is being led by French President Nicolas Sarokozy, who happens to be the current Chairman of both the G8 and G20. Recently, he has used his podium for populist rants against the international financial system. To his credit, Sarkozy has done more than bluster. He is fighting to advance the idea for a minute tax on all financial transactions, with the aim of reducing volatility and raising money for cash-strapped governments.

The so-called Tobin tax was first proposed in 1971 by Nobel Laureate James Tobin. While it has always enjoyed support from a handful of leftist economists, it has never been seriously considered by any western country. In the wake of the financial crisis, however, anger towards speculation seems to be peaking, and some governments might finally have enough political capital to push forward the idea. In fact, France has already obtained the tepid support of other EU members, notably Austria. In addition, the Economic and Monetary Affairs Committee of the European Parliament has backed the idea. The EU is fighting to keep the Euro alive and its member states solvent, and it clearly resents the (perceived) role of speculators in betting on default and breakup.

Proponents of the Tobin tax generally cite the amount of revenue it could raise as its chief benefit. For example, it has been estimated that a .005% on forex transactions could raise $26 Billion worldwide, while a .05% tax on all financial transactions could generate as much as $700 Billion in revenue. Even though studies suggest that it wouldn’t do much to reduce volatility (and perhaps speculation), the fact that it shouldn’t destabilize markets is enough to satisfy some of its naysayers.

Not surprisingly, the US remains opposed to such a policy, on the grounds that it could “send misleading signals that could hamper investment to end extraction and cause production bottlenecks.” This kind of incantation rings hollow, however, and it’s clear that the biggest obstacle to its being implemented is almost certainly the bank lobby, which has insisted that a Tobin tax would “cause serious damage to this highly efficient [forex] market.”

Personally, I’m a cautious advocate of the Tobin tax. At .005%, it would levy $10 on every round-trip lot ($100,000) forex transaction. This would punish those that engage in leveraged account-churning and computerized, rapid-fire trading, without impacting those that take a longer-term approach to forex. In addition, it would impact institutional traders and investment banks (which currently monopolize all financial markets) much more than retail traders. Then again, they would probably just shift more of their trading into unregulated, private markets.

At this point, the Tobin tax is still probably a long-shot. The fact that it’s being seriously considered, however, is nothing short of remarkable.

Presidents Day And More!

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By Mike Conlon | February 21, 2011

Today is President’s Day here in the US so it is a bank holiday and most financial markets are closed for the dayâ€"yet the forex market is open for trading! However, volume in the US session will be noticeably lighter as the bank holiday will reduce participation.

So today’s blog article will be an abridged versionâ€"as I still need to make my way to the trader’s expo here in NY where I will be giving a presentation at 3:30. And I also have a minor snowstorm to navigate, though this winter has left me indifferent to the fluffy white stuff as it has become less of a surprise and more of an expectation.

Some “surprises� coming from the Arab nations have heightened risk in the region and threaten stability as protests in different nations are met with different responses. Just days after protests in Egypt forced change in the government, it is not going as well in Libya as it is already been reported that over 200 people have died. This situation could explode into Civil War, as warned by the son of leader Quaddafi.

This situation is far from over and represents a major risk to global stability. As such, the forex market is in risk aversion mode.

Overnight, German business confidence figures were higher but the Euro is trading lower on risk themes. There will be GDP and CPI data figures released later this week.

One anomaly taking place this morning is a higher Kiwi, as expectations of tomorrow’s inflation expectation report has traders postioning accordingly.

At the end of the week, both US and UK GDP figures will be released.

So this week is busy with news, while heightened risk from Arab countries will keep the markets on edge. It is not quite smooth sailing this week which like the snow in NY is not surprising but more of an expectation.

If we are able to run this economic gauntlet this week without too much damage, then I may be surprised! So the only trading I’ll be doing this week will be demonstrations at the Expo, and if you are nearby come stop in and say ‘hi’.

For the rest of you on the internet:

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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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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Bank of Canada Leaves Rates at 1%

The Bank of Canada has left its trendsetting interest rate at one per cent, unchanged since it last raised rates in September. The central bank says global conditions have improved slightly since its last full report in October, and so have Canada’s economic prospects. But it also says risks remain and the high dollar and low productivity will continue to weigh on Canadian exports and output growth.

The bank expects the economy to grow a moderate 2.4 per cent this year and only slightly better next year at 2.8 per cent. It says the economy won’t return to full capacity until the end of 2012.

Source: The Canadian Press

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Coming In Hot!

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By Mike Conlon | January 18, 2011

UK CPI data came in earlier this morning WAY hotter than expected, showing inflation at 3.7% vs. an expectation of 3.4%.  This is now becoming a problem in the UK as inflation is nearly TWICE as much as the 2% target and markedly higher than the BOE limit of 3%, and will require yet another letter of explanation from the BOE to the Chancellor of the Exchequer.

In the very least, this will put major pressure on the BOE to change their stance on accommodative monetary policy, and the minutes from the BOE meeting will show whether or not individual voting members are starting to cave to the pressure.  While a change to policy could potentially help the Pound rise, the threat of stagflation may be a greater detriment going forward.  Retail prices came in as expected.

In Canada, the Bank of Canada left rates unchanged this morning as was expected and boosted their outlook for growth in 2011 and 2012.  However, dovish comments about the Loonie’s role in that growth have helped send it lower.

In the EU, Euro zone and German economic sentiment came in better than expected, but the current situation survey came in less than expected yet the Euro is higher as there is a hint of confidence that progress is being made with regard to the debt crisis.

In the US, empire manufacturing figures came in higher than last month with a reading of 11.92, but missed expectations of 12.5.

Today is a positive day for world markets, with Dollar weakness driving risk appetite.

In the forex market:

Aussie (AUD):   The Aussie is higher as risk appetite has increased on a renewed outlook for the Euro and the belief that rebuilding due to the damage from the flooding may encourage business activity.

Kiwi (NZD):   The Kiwi is mixed today as the market weighs the balance between risk appetite and the news that home prices declined for 3rd time in 4 months, showing signs that a sluggish economy may be hampering demand.

Loonie (CAD):   The Bank of Canada left rates unchanged at 1% as expected and increased their growth forecast for the economy.  However, comments that interest rate hikes would be “carefully considered” we seen as dovish which has helped push the Loonie lower this morning, in addition to lower oil prices.  (Click chart to enlarge)

Euro (EUR):  The Euro is higher across the board even though yesterday’s meeting of finance ministers failed to produce an agreement with regard to the how to combat the debt crisis.  While there is some speculation that the emergency facility (EFSF) will be expanded, nothing concrete has emerged as of yet.

Pound (GBP):  The Pound is trading higher against all but the Euro, as inflation data came in much higher than expected.  The minutes of the rate policy meeting are due out on Jan. 26th, so we will see if there is any further support for less accommodative policy, perhaps in the form of a removal of asset purchase plan.   (Click chart to enlarge)

Dollar (USD):   The Dollar is mostly lower despite a higher Empire manufacturing number though it fell just short of expectations.  The market is still grappling with whether or not the Dollar should rise or fall with equity prices (which are higher this morning).

Yen (JPY):   The Yen is mixed as well as individual fundamental weakness in Canada and NZ is causing an un-wind of carry trades, though it looks like those money flows are making their way to the Aussie.  Euro and Pound strength cause Yen selling.

As the different fundamental data comes in around the globe, it is easy to see how hot many flows will sell weakness and buy strength.  However, sometimes the perception of strength is actually weakness, and vice-versa.

Take the Pound for example.  There was immediate Pound strength right out of the gate as CPI data was reported.  The thought was that higher inflation will cause the BOE to act to remove accommodative monetary policy.  But upon further inspection, this may actually produce a negative economic condition whereby a shrinking economy due to austerity and higher prices due to inflation create stagflation which could essentially derail the UK economic recovery.

So round and round she goes and where it stops, nobody knows.  The forex market tracks worldwide money flows and money always has to “land somewhere”.  Whether it is another currency or another market, investors will seek out higher yielding assets when times seem stable and promising, and will run to safe havens when times look bleak.

This is the essence of the forex market so it is important that you have a good understanding of the market fundamentals if you are to succeed.

Do you have a good understanding of the fundamentals?  If not, check out our currency trading courses!

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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Chinese Yuan Continues to Tick Up

At the very end of 2010, the Chinese Yuan managed to cross the important psychological level of 6.60 USD/CNY, reaching the highest level since 1993. Moreover, analysts are unanimous in their expectation that the Chinese Yuan will continue rising in 2011, disagreeing only on the extent. Since the Yuan’s value is controlled tightly  by Chinese policymakers, forecasting the Yuan requires an in-depth look at the surrounding politics.

While American politicians chide it for not doing enough, the Chinese government nonetheless deserves some credit. It has allowed the Yuan to appreciate nearly 25% in total, which should be just enough to satisfy the 25-40% that was initially demanded. Meanwhile, over the last five years, China’s trade surplus has fallen dramatically, to 3.3% of GDP in 2010, compared to a peak of 11% in 2007. In fact, if you don’t include trade with the US, its surplus was basically nil this year.

Therein lies the problem. Despite the fact that prices in Chinese exports should have risen 25% (much more if you take inflation and rising wages into account) since 2004, the China/US trade balance has remained virtually unchanged, and its current account surplus has actually widened. As a result, China’s foreign exchange reserves increased by a record amount in 2010, bringing the total to a whopping $2.9 Trillion! (Of course, these reserves should be thought of as a monetary burden rather than pure wealth, to the same extent as the US Federal Reserve Board’s Balance Sheet must one day be wound down. In the context of this discussion, however, that might be a moot point).

Meanwhile, China is trying to slowly tilt the structure of its economy towards domestic consumption, which is increasing by almost every measure. Its Central Bank is also slowly hiking interest rates and raising the reserve requirements of banks in order to put the brakes on economic growth and rein in inflation. Finally, it is trying to encourage internationalization of the Yuan. There now 70,000 Chinese trade companies that are permitted to settle trades in Chinese Yuan. In addition, Bank of China just announced that US customers will be able to open up Yuan-denominated accounts, and the World Bank became the latest foreign entity to issue an RMB-denominated “Dim-Sum Bond.”

There is also evidence that the Chinese Government’s top leadership â€" with whom the US government directly negotiates â€" is actually pushing for a faster appreciation of the RMB but that it faces internal opposition. According to the New York Times, “The debate over revaluing the renminbi… has not advanced much partly because of a fight between central bankers who want the currency to rise and ministers and party bosses who want to protect the vast industrial machine that depends on cheap exports for survival.” In fact, the Bank of China (PBOC) recently warned, “Factors such as the country’s trade surplus, foreign direct investment, China’s interest rate gap with Western countries, yuan appreciation expectations, and rising asset prices are likely to persist, drawing funds into the country,” while a senior Chinese lawmaker pushed back that a “rise in the yuan’s value won’t help the country to curb inflation.”

Some analysts expect a big move in the Yuan that corresponds with this week’s US visit by China’s Prime Minister, Hu Jintao. The average call, however, is for a continued, steady rise. “China’s currency will strengthen 4.9 percent to 6.28 by the end of 2011, according to the median estimate of 19 analysts in a Bloomberg survey. That’s over double the 2 percent gain projected by 12-month non-deliverable forwards.” As I wrote in my previous post on the Chinese Yuan, however, it ultimately depends on inflation â€" whether it keeps rising and if so, how the government chooses to tackle it.

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Fed Paper: Power of Technical Analysis in Forex is Declining

Being a practitioner of fundamental analysis, you could say that I’m always on the lookout for hard evidence that fundamental analysis is superior to technical analysis. Thus, I was delighted to discover a working paper (“Technical Analysis in the Foreign Exchange Market“) by the St. Louis Branch of the Federal Reserve Bank, released just this month. Alas, the paper barely touched upon fundamental analysis, but its conclusions on technical analysis in the currency markets were startling. In short, the effectiveness of technical analysis in the currency markets has declined steadily since the 1970s, such that only the most sophisticated/complicated strategies are currently profitable.

Rather than conduct original research, the report’s authors â€" Christopher J. Neely, an assistant vice president and economist at the Federal Reserve Bank of St. Louis, and Paul A. Weller, the John F. Murray Professor of Finance at the University of Iowa â€" performed a meta analysis of the existing research. They cited a litany of studies, covered a variety of topics, sometimes with contradictory conclusions. In order to ensure comprehensiveness, they looked at the profitability of numerous types of technical analysis indicators, across numerous currency pairs, over time, in different types of trading environments, and adjusted for risk.

All of the earlier studies, dating back to the 1960s, established the profitability of technical analysis, even when it was simplistic. Since then, however, most studies have shown steadily declining effectiveness: “TTRs [Technical Trading Rules] ere able to earn genuine risk-adjusted excess returns in foreign exchange markets at least from the mid-1970s until about 1990…and that rule profitability has been declining since the late 1980s.” The same trend has unfolded in the last decade, as traders have relied increasingly on computerized trading strategies: “Kozhan and Salmon (2010), using high frequency data, find that trading rules derived from a genetic algorithm were profitable in 2003 but that this was no longer true in 2008.”

Given that the two authors also concede that the financial markets are undoubtedly inefficient and that currency markets in particular are filled with observable trends, how should we understand this decline in the effectiveness of technical analysis? In one word, the answer is competition. “Profit opportunities will generally exist in financial markets but…learning and competition will gradually erode ["arbitrage away"] these opportunities as they become known.” In addition, there has been a “dramatic rise in the volume of algorithmic trading,” which has given rise to a so-called financial arms race to develop ever-more sophisticated trading strategies.

Indeed, the research shows that “more complex strategies will persist longer than simple ones. And as some strategies decline as they become less profitable, there will be a tendency for other strategies to appear in response to the changing market environment.” In addition, technical analysis that is used to trade exotic (i.e. less liquid) currencies is more likely to be profitable than major currencies, especially the US Dollar.

The report opens the door to further research, by indicating that “Technical trading can be consistently profitable in certain circumstances.” As if it wasn’t already clear, though, the vast majority of technical traders (perhaps all traders for that matter) are destined to be outmaneuvered and will ultimately lose money trading forex. Another way of looking at this, however, is that the the savviest traders â€" those that can spot complex trends and execute trading strategies quickly â€" still have a chance at earning consistent profits.

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Citizens Of The World Unite!

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By Mike Conlon | January 14, 2011

Here It Comes!

Over the last few days I have been harping on the inflation and it is starting to rear its ugly head.  Yesterday, ECB President Trichet surprised the markets by mentioning the risk it imposes to economic recovery.  One would think that the sovereign debt issues he is dealing with would be caution enough, but he took the opportunity to add fuel to the fire with his hawkish comments, sending the Euro higher.

This did not escape the Chinese, however, as they raised bank reserve requirements by 50 basis points in an attempt to curb lending to reduce their money supply to slow down demand.  Treasury Secretary Geithner noted yesterday that Yuan appreciation may not be such a big deal anymore, as higher prices in China will reduce demand for their goods, which will reduce their overall current account surplus.  On a personal note, I can confirm that indeed prices and domestic demand in China are increasing as businesses that have been working with China are now seeking cheaper alternatives.  Keep your eye on India, folks.

Earlier this morning, German CPI data came in as expected but showing signs that inflation may be on the rise which would fall in line with Trichet’s comments.  This could cause a rise in Euro zone interest rates, despite the need for cheaper re-fi costs for the PIIGS countries.  PPI input data in the UK was also higher, boosting the Pound.

And lastly, CPI data here in the US came in hotter than expected, as the headline number showed a 1.5% rise vs. an expectation of 1.3%.  This comes as no surprise as agricultural commodities have been soaring higher, so be prepared to pay more for food and energy unless something is done to combat this problem.

However, equities and commodities markets are lower which highlights China’s influence on those markets as they are the only country that appears to be doing something to attempt to put the brakes on from a monetary policy standpoint.   Though allowing their currency to appreciate would go a long way to combat their problem.  In time.

In the forex market:

Aussie (AUD):   The Aussie is lower across the board as the China’s attempts at a slowdown will affect the Australian economy greatly as China is the largest buyer of Australian exports.

Kiwi (NZD):   The Kiwi is also lower for the same reasons as the Aussie, for as Australia goes so does NZ only to a lesser extent.

Loonie (CAD):   The Loonie is also lower this morning as a pullback in commodities, particularly oil, is weighing on the currency.   However, it is strengthening vs. USD off of the morning lows as it traded close to parity.  (Click chart to enlarge)

Euro (EUR):   The Euro is mixed this morning, trading higher against the commodity currencies but lower against the rest.  After yesterday’s spectacular run higher, the Euro may be experiencing a bit of “buy the rumor, sell the news” as CPI data in Germany was as expected.  In addition, Euro zone trade balance figures showed a deficit vs. an expected surplus.  (Click chart to enlarge)

Pound (GBP):  The Pound is higher across the board as PPI input data came in much higher than expected.   If this translates over to higher CPI data (which is to be reported next Tuesday), then the BOE may be under major pressure to do something about monetary policy through either a reduction of bond-buying or a rate hike.

Dollar (USD):   The Dollar is giving back earlier gains after the CPI data was reported as the market has no conviction that the Fed will do anything about rates or QE2 anytime soon and would prefer to allow US citizens to pay the extra tax (inflation) on necessities rather than potentially harm the banks and the housing market by normalizing policy.  The Lame-stream media is reporting that retail sales rose .6% for the month of December, which makes 6 months in a row, but insiders know that the market was really expecting a rise of .8%.  Never ruin a good story for the want of a few facts!

Yen (JPY):   The Yen is mixed this morning as various carry trades are unwound and the safe haven status of the Yen is in demand as the potential Chinese slowdown affects demand and risk appetite.

Citizens of the world unite!

Consider this a “capitalist manifesto”.  Your government (wherever you are) has sold you down the river to protect the banks and the financial elite.  You know, the people who got the world into this financial mess in the first place.

Now they expect you to pay MORE for the basic necessities you require to live.  How are they doing this?  Through the insidious tax known as inflation.  Inflation affects us all equally, but not proportionally.

When prices of food and energy move higher, it becomes harder to make ends meet, especially for working-class folk.   Do you think that the CEO of a big bank cares that it costs that the price of milk goes higher, or that the cost to heat one’s home is through the roof.  Not at all, its pocket-change to him.

Yet he’s protected by the Fed under the guise of “too big to fail”, so he gets to not only keep his job but pay himself an enormous bonus to boot!  Never mind the fact that it was you, the tax-payer, who allowed this charade to continue despite having no say in the matter.

Now they want you to pay even more!  This isn’t just a US phenomenon, look at what is happening around the globe.  A weak US dollar is driving prices higher and exceptionally low interest rates around the globe have flooded the world economy with too much cash chasing too few goods.  Central banksters could reduce this through tightening monetary policy by raising rates, but they are too afraid to harm their bankster buddies!

So what can you do about it?  The answer friends, is the forex market.  Protect yourself from those who want to harm you by allowing your wealth to disappear through inflation.  It’s no coincidence that central bankster is not an elected position!

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 Prices Rise as Energy Costs Increase

Wholesale prices rose sharply in the US during the month of December but the jump was due almost entirely on energy cost increases. The Producer Price Index rose 1.1 percent compared to 0.8 percent the month before. However, heating oil was up 12.3%, while the cost of gasoline rose 6.4%.

Excluding energy and food costs, prices rose just 0.2% last month. This actually represents a slowdown from November’s 0.3% increase.

Source: BBC News

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Japanese Yen Due for a Correction in 2011

Based on every measure, the Japanese Yen was the world’s best performing major currency in 2010. It notched up gains every one of its 16 major counterparts, and was the only G4 currency to appreciate on a trade-weighted basis. Against the US Dollar, it rose 10%, and touched a 15-year high in the process. However, there is reason to believe that the Yen is now overvalued, and that 2011 will see it decline to more sustainable levels.

I am still somewhat baffled as to why the Yen has risen so inexorably. It is said that “Hindsight is 20/20,” but in this case the benefit of hindsight doesn’t really provide any additional clarity. Of course, there was the Eurozone Sovereign debt crisis and the consequent shift of funds into safe-haven currencies, but let’s not forget that the fiscal problems of Japan are even more pronounced than in the EU. Premiums on credit default swaps signal that the probability of a Japanese government default is twice as high as it is for the US, and there are rumors of a downgrade in its sovereign credit rating. As one commentator summarized, “Just how the Japanese have got away with running up a debt to GDP ratio of over 200% (higher than the PIIGS and the U.S.) is beyond me.” Of course, it helps that this debt is financed almost entirely by domestic savings and is consequently not vulnerable to the changing whims of foreigners, but even so!

Meanwhile, the opportunity cost of investing in Japan is high. While inflation is moot, equity returns are low and bond yields are even lower. “Japanese 10-year yields, the lowest among 32 bond markets tracked by Bloomberg data, will end 2011 at 1.24 percent from 1.19 percent today, according to a weighted forecast of economists surveyed by Bloomberg News.” Combined with low short-term rates, it would seem that the Japanese Yen would be the perfect candidate for a carry trade strategy.

Although foreigners remain net buyers of Japanese Yen, the current account/trade surplus is gradually narrowing, with the former falling 16% year-over-year and the latter dropping 46%. It seems that “consumers overseas increasingly spurn Japanese products in favor of lower-priced goods from South Korea and other nations.”

Even the Japanese seem to prefer other currencies. According to NIKKEI, “Japanese investors were net buyers of foreign mid- and long-term bonds to the tune of 21.94 trillion yen in 2010, the most since comparable data began being compiled in January 2005.” Japanese companies are also taking advantage of the expensive Yen and strong balance sheets to buy overseas assets. The Economist reports that, “Japanese companies are sitting on a hoard of cash totalling more than ¥202 trillion ($2.4 trillion)…Many companies have earmarked vast sums for acquisitions in 2011 and beyond.”

With GDP projected to fall to 1% in 2011, there would seem to be very little reason to continue buying the Yen. According to the most recent CFTC Commitment of Traders Report, speculators are building up massive short positions in the Yen. Meanwhile, the Central Bank of China is quietly paring down its Yen holdings. Even the Bank of Japan seems to have embraced this inevitability, as it is has already stopped intervening in forex markets on the Yen’s behalf.

According to a Bloomberg News Survey, “Japan’s currency will tumble almost 10 percent against the dollar this year.” Very few analysts think that the bottom will complete fall out from under the Yen, but the majority (myself included) expect a correction of some kind.

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All Eyes on the US Dollar in 2011

According to Standard Life Investments, the US Dollar will be one of the top currencies in 2011. (The other currency they cited was the British Pound). How can we understand this notion in the context of record high gold prices and commentary pieces with titles such as “Timing the Inevitable Decline of the U.S. Dollar?”

The Dollar finished 2010 on a high note, both on a trade-weighted basis and against its arch-nemesis, the Euro. Speculators are now net long the Dollar, and according to one analyst, it is now fully “entrenched in rally mode.” Never mind that its performance against the Yen, Franc, and a handful of emerging market currencies was less than stellar; given all that happened over the last couple years, the fact that the Dollar Index is trading near its recent historical average means that the bears have some explaining to do.

To be sure, none of the long-term risks have been addressed. US public debt continues to surge, and will not likely abate in 2011 due to recent tax cuts. Short-term interest rates remain grounded at zero, and long-term yields have only just begun to inch up, which means that risk-taking investors still have cause to shun the Dollar. Ironically, signs of economic recovery in the US have reinforced this trend: “The [positive economic] data, which one would ultimately assume is positive for the U.S., looks better for risk, which in turn puts downward pressure on the dollar.” Finally, the the Financial Balance of Terror makes the US vulnerable to a sudden decision by Central Banks to dump the Dollar.

So what’s driving the Dollar in the short-term? The main factor is of course continued uncertainty in the Eurozone over still-unfolding fiscal crisis, which is directly driving a shift of capital from the EU to the US. Next, the budget-busting tax cuts that I mentioned above are predicted to both boost economic growth and make it less likely that the Federal Reserve Bank will have to deploy the entire $600 Billion that it initially set aside for QE2. (To date, it has spent “only” $175 Billion in this follow-up campaign, compared to the $1.75 Trillion that it deployed in QE1). According to The Economist, “JPMorgan raised its growth forecast for the fourth quarter of next year to 3.5% from 3% as a result [of the tax cuts]. Macroeconomic Advisers, a consultancy, says the new package could raise growth to 4.3% next year, up from its current forecast of 3.7%.”

In fact, long-term rates on US debt have started to creep up. They recently surpassed comparable rates in Canada, and even risk-taking investors are taking notice: “U.S. bond yields are attractive and interesting again,” indicated one analyst. Of course, when analyzing the recent increase in bond yields, it’s impossible to disentangle inflation expectations from concerns over default from optimism over economic. Nevertheless, the consensus is that rates/yields can only rise from here: “The CBO [Congressional Budget Office] estimates that interest rates on 3-month bills and 10-year notes will reach 5.0% and 5.9%, respectively, by 2020.”

As if this wasn’t enough, the exodus out of the US Dollar over the last few decades has virtually ceased, with the US Dollar still accounting for a disproportionate 62.7% of global forex reserves. Furthermore, economists are now coming out of the woodwork to defend the Dollar and argue that its supposed demise is overblown. At last week’s annual meeting of the American Economic Association (and in a related research paper), Princeton University economist Peter B. Kenen “argued that neither Europe’s nor China’s currency presents a valid substituteâ€"nor an International Monetary Fund alternative to the dollar that was created some 40 years ago.” Even if the RMB was a viable reserve currency â€" which it isn’t â€" Kenen points out that for all its bluster, China has shied away from taking a more active leadership role in solving global economic issues.

In short, as I’ve argued previously, the Dollar is safe, not just for the time being, but probably for a while.

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