Happy Tax Day!

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By Mike Conlon | April 15, 2011

OK, not really. Do you know where your money goes? Well I certainly don’t, and while I am not happy about having to write a big check, at least this means that my trading has been successful. Many Americans are in the same boat, and are disappointed by the lack of stewardship coming from our politicians.

Today the House will vote on the Republican budget plan, but it is DOA in the Senate so let the negotiations begin. Major reform is necessary but very unlikely to take place. I would advocate some sort of polling system, where taxpayers could “allocate” their tax dollars to areas that they feel are important. Take the corrupt politicians out of the equation.

One place where they don’t have to worry budget deficits is China, who reported overnight 9.7% GDP growth. This is an amazing figure considering the state of the global economy, however the reported 5.4% CPI data shows that inflation is still a problem there, which could mean further rate hikes which could potentially slow economic growth for the periphery that depends on Chinese growth. Perhaps it has something to do with the $3 Trillion dollars in currency reserves that China holds, all thanks to their currency peg.

In the Euro zone, Irish debt was downgraded, Greek debt may need to be restructured, and CPI came in a little hotter than expected.

Meanwhile the US Fed continues to deny that inflation exists here in the US, and today’s CPI data will likely prove their point. I guess if the price of things that nobody cares about continues to go down, then it is acceptable to have $4 gasoline. The intellectually dishonesty is sickening frankly.

So stock are set to open lower, and commodities have pulled back some as there is risk aversion to start the day.

In the forex market:

Aussie (AUD): The Aussie is lower as China is the largest importer of Australian raw materials and if the Chinese raise rates to slow inflation than that could affect Aussie exports negatively. (Click chart to enlarge)

Kiwi (NZD): The Kiwi is actually trading mostly higher as the expectation of rate hikes and a higher rate differential after the emergency cuts the RBNZ made to provide relief from the earthquake, may have stoked inflation.

Loonie (CAD): The Loonie is mostly lower as commodities are pulling back on the threat of a potential Chinese slowdown. It has long been rumored that China is the driver behind the recent oil price spike. More US Fed subterfuge if you ask me.

Euro (EUR): The Euro is lower across the board as the Irish debt downgrade and the possible Greek debt restructuring is being the debt crisis back into to focus. Ignoring this won’t make it go away, so some concrete plans could allay market fears, especially if the ECB is going to continue to raise rates.

Pound (GBP): The Pound is also lower as the UK’s close ties to Ireland are helping to weigh on Sterling. With no news out of the UK today, British prospects are looking up when compared to the others.

Dollar (USD): The Dollar is mostly higher on risk aversion and CPI data came in slightly higher than expected, showing inflation at 2.7%. I don’t want to get into the headline vs. core debate, but it is clear that the Fed is intentionally trying to avoid the reality. Stagflation, here we come!

Yen (JPY): The Yen is strengthening as carry-trades are being unwound due to the threat of a potential Chinese slowdown. (Click chart to enlarge)

When both monetary and fiscal policy in a country is deplorable, it makes no sense to invest there. Yes, I am talking about the USA. Politicians can debate the ideology back and forth, but at the end of the day the lack of leadership is truly striking.

Enter the Fed, who will some claim to just be stupid and not malevolent with regard to the way that they do things. In the meantime, hardworking Americans will continue to do their patriotic duty and send in their taxes, so politician/celebrities can fly around on private jets and make policies that nobody wants or needs.

So Happy Tax Day! I hope you are having as much fun as I am!

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: April 10-15

This week the dollar had the ‘classic’ opportunity to rally aggressively. Global risk appetite has subsided, commodity currencies have softened and investors were willing to take profit. Instead, we have witnessed only a feeble attempt to rise.

Trichet and company’s hawkishness, mixed with the Fed’s dovish response to higher oil prices continue to make the EUR an increasingly attractive alternative to the dollar. With the Fed expected to now trail all other Cbanks when it comes to tightening, is putting the dollar near the bottom of the G10 carry trade league and up there with the classic funding currencies.

Expect the fears of a debt default and reserve diversification to weigh heavily on the global ‘reserve’ currency. Investors are demanding higher yield to account for that risk and QE2 has done a good job in keeping them artificially low. Asian Cbanks are keen to diversify their dollar denominated reserves into other currencies like the EUR, CAD or other higher yielding currencies.

EUROPE

• French industrial production was in line with expectations at +0.4%, m/m, while Italian IP was slightly weaker at +1.4% vs. +1.7% consensus. This put the French y/y IP growth rate at a healthy +5.6% in Feb., and combined with last week’s strong German IP number, continues to point to robust industrial momentum in core-Europe. Irish IP, on the other hand, disappointed at -2.4% in Feb.
• In Norway, CPI fell in Mar. to +1% from +1.2% y/y in Feb. Core-inflation was flat and relatively subdued at +0.8%, y/y.
• UK CPI inflation was much weaker than the consensus expectation for a flat reading. It fell to +4% y/y in Mar. after rising to twenty-eighth month high of +4.4% in Feb. There was a sharp drop in food inflation, driving down the headline print, but core was also softer and the drop there was broad-based. BoE tightening expectations for the next 12-months has fallen from 75bp to 59bp.
• BRC data saw UK retail sales fall -3.7%, y/y, in March (largest decline in 16-years). Higher oil prices, VAT and inflation, low wage growth and the prospect of further fiscal policy tightening likely weighed on consumer spending. Combining weaker than expected real economic data and the lack of a convincing hawkish shift from the MPC is pushing a BoE hikes further out the curve.
• UK employment data again failed to impress. Claimant count rate was unchanged at +4.5% in Mar., with a small increase in jobless claims. Employment rose +143k in the Dec. to Feb quarter after the -69k drop in the Sept to Nov period, dragging the unemployment rate lower to +7.8% from +8%.
• Press speculation on risks of Greek restructuring has caused European peripheral spreads to widen this week (Portugal, Spain and Ireland), reversing last weeks tightening. German finance minister Schaeuble said that additional steps will be taken if an analysis, expected in June, shows that Greek debt is unsustainable.
• Ireland’s foreign-and local-currency government bond ratings were cut by two notches to Baa3 from Baa1 by Moody’s
• Euro area HICP inflation was revised up to +2.7%, y/y, in Mar. from the +2.6% flash estimate. Core-inflation accelerated to +1.3%, y/y, from +1% in Feb. Continued price pressures in the Euro-zone should help reinforce the ECB’s rate hike expectations.

Americas

• US trade gap narrowed in Feb. to -$45.76b, but by less than expected. The underlying details were weaker, as the pace of decline in imports outpaced that of exports.
• The BoC stood pat on rates this week (+1%). Governor Carney has raised the Bank’s growth forecast for 2011 to +2.9% from +2.4% and predicted that the economy will now return to full capacity in mid-2012, six-months earlier than originally forecasted. The Governor is worried that the currency could weigh on growth and inflation, citing the loonie as a headwind to growth ‘twice’ in his statement.
• US retail sales just missed expectations (+0.4% vs. +0.5%), but the underlying details were positive. The core-component (ex-autos and energy) posted another decent gain (+0.8%), suggesting that the improvements in the labor force are finally having an affect on consumer spending.
• The Fed’s Beige Book reported that the US economy continues to expand at a ‘moderate’ pace from mid-Feb through Mar. They indicated that the weak job market was also doing better, with hiring still strong in manufacturing.
• The BoC’s MPR details show that policy makers expect to gradually hike interest rates through 2013, while warning that the strong CAD could hurt exports and act as a drag on growth, as well as put added downward pressure on inflation through cheaper imports.
• The number of people filing for US unemployment jumped +27k, w/w, to +412k, closer to the beginning of the year reporting when seasonal volatility impaired readings. Analysts are explaining the unexpected rise away to the effects of adjusting to a new quarter.
• US producer prices grew at a slower pace in Mar. (+0.7% vs. +1.6%), even the growth in core-producer prices remain relatively subdued at +0.3%, m/m, reducing upward pressure on inflation.
• Commodity price growth continues to weigh on headline inflation (+0.5%), with both food and fuel prices up further in Mar. Core-inflation (+0.1%) moderated on a monthly basis in Mar., highlighting once again that inflation is contained in the US.
• Empire manufacturing index extended gains for the fifth straight month in Apr., posting a bigger-than-expected pick-up of +4.2pts to 21.7 (highest level in a year). Proof that that the US industrial sector is regaining momentum, and is supportive of general economic activity.
• Headline US industrial output bounced back more than expected, up +0.8%, m/m, in Mar. The underlying details suggest broader strength.

ASIA

• Chinese imports hit a new all-time high of $152b, broadly matched by exports (just short of a record high). In the 1st Q, the dollar value of exports and imports were up +25% and +33%, y/y.
• Japanese authorities indicated that they were lifting their assessment of the severity of the nuclear accident from level 5 to level 7.
• BoK kept its policy rate on hold at +3.00% as expected.
• PBoC continued to fix USDCNY to a new low each day all week.
• MAS re-centered their exchange rate policy band upwards maintaining its hawkish stance. The decision should support market expectations of further SGD appreciation.
• Japanese weekly portfolio flow data showed investors net buyers JPY176bn of foreign bonds and net sellers JPY161bn of foreign equities for net outflows of JPY16.9bn.
• Strong Chinese growth and inflation numbers have revived concerns over further aggressive tightening by the PBoC. Chinese GDP was a solid +9.7%, y/y, in the 1st Q (consensus +9.4%). Inflationary pressures remain elevated, with CPI inflation rising to +5.4%, y/y, in Mar. from +4.9% in Feb.

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Record Commodities Prices and the Forex Markets

Propelled by economic recovery and the recent Mideast political turmoil, oil prices have firmly shaken off any lingering credit crisis weakness, and are headed towards a record high. Moreover, analysts are warning that due to certain fundamental changes to the global economy, prices will almost certainly remain high for the foreseeable future. The same goes for commodities. Whether directly or indirectly, the implications for forex market will be significant.

First of all, there is a direct impact on trade, and hence on the demand for particular currencies. Norway, Russia, Saudia Arabia, and a dozen other countries are witnessing record capital inflow expanding current account surpluses. If not for the fact that many of these countries peg their currencies to the Dollar and/or seem to suffer from myriad other issues, there currencies would almost surely appreciate. In fact, the Russian Rouble and Norwegian Krona have both begun to rise in recent months. On the other hand, Canada and Australia (and to a lesser extent, New Zealand) are experiencing rising trade deficits, which shows that their is not an automatic relationship between rising commodity prices and commodity currency strength.

Those countries that are net energy importers could experience some weakness in their currencies, as trade balances move against them. In fact, China just recorded its first quarterly trade deficit in seven years. Instead of viewing this in terms of a shift in economic structure, economists need to understand that this is due in no small part to rising raw materials prices. Either way, the People’s Bank of China (PBOC) will probably tighten control over the appreciation of the Chinese Yuan. Meanwhile, the nuclear crisis in Japan is almost certainly going to decrease interest in nuclear power, especially in the short-term. This will cause oil and natural gas prices to rise even further, and magnify the impact on global trade imbalances.

A bigger issue is whether rising commodities prices will spur inflation. With the notable exception of the Fed, all of the world’s Central Banks have now voiced concerns over energy prices. The European Central Bank (ECB), has gone so far as to preemptively raise its benchmark interest rate, even though Eurozone inflation is still quite low. In light of his spectacular failure to anticipate the housing crisis, Fed Chairman Ben Bernanke is being careful not to offer unambiguous views on the impact of high oil prices. Thus, he has warned that it could translate into decreased GDP growth and higher prices for consumers, but he has stopped short of labeling it a serious threat.

On the one hand, the US economy is undergone some significant structural changes since the last energy crisis, which could mitigate the impact of sustained high prices. “The energy intensity of the U.S. economy â€" that is, the energy required to produce $1 of GDP â€" has fallen by 50% since then as manufacturing has moved overseas or become more efficient. Also, the price of natural gas today has stayed low; in the past, oil and gas moved in tandem. And finally, ‘we’re closer to alternative sources of energy for our transportation,’ ” summarized Wharton Finance Professor Jeremy Siegal. From this standpoint, it’s understandable that every $10 increase in the price of oil causes GDP to drop by only .25%.

On the other hand, we’re not talking about a $10 increase in the price of oil, but rather a $50 or even $100 spike. In addition, while industry is not sensitive to high commodity prices, American consumers certainly are. From automobile gasoline to home eating oil to agricultural staples (you know things are bad when thieves are targeting produce!), commodities still represent a big portion of consumer spending. Thus, each 1 cent increase in the price of gas sucks $1 Billion from the economy. “If gas prices increased to $4.50 per gallon for more than two months, it would ‘pose a serious strain on households and could put the entire recovery in jeopardy. Once you get above $5, [there is] probably above a 50% chance that the economy could face a downturn.’ ”

Even if stagflation can be avoided, some degree of inflation seems inevitable. In fact, US CPI is now 2.7%, the highest level in 18 months and rising. It is similarly 2.7% in the Eurozone and Australia, where both Central Banks have started to become more aggressive about tightening monetary policy. In the end, no country will be spared from inflation if commodity prices remain high; the only difference will be one of extent.

Over the near-term, much depends on what happens in the Middle East, since an abatement in political tensions would cause energy prices to ease. Over the medium-term, the focus will be on Central Banks, to see if/how they deal with rising inflation. Will they raise interest rates and withdraw liquidity, or will they wait to act for fear of inhibiting economic recovery? Over the long-term, the pivotal issue is whether economies (especially China) can become less energy intensive or more diversified in their energy consumption.

At the moment, most economies are dangerously exposed, with China and the US topping the list. Russia, Norway, Brazil and a select few others will earn a net benefit from a boom in prices, while most others (notably Australia and Canada) are somewhere in the middle.

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EUR and Dollar trade on fear

With all the information about the Japanese problems, Chinese monetary tightening, Euro-zone debt debacle has investors confused and/or lacking confidence. It’s no wonder we have these tight non-directional trading ranges with some liquidity vacuum pockets in between. One day data is positive for growth, the next, the MAS is allowing further gains in its currency to combat inflation or the market ponders on Greek debt restructuring worries.

Goldman is going out on a limb again. Earlier this week they suggested lightening up on the one directional lemming commodity positions. Now, its the dollars turn. Despite the currency being undervalued, they believe it will take significant changes ‘to spark a turn around in the buck’s fortune’. They state the obvious, a pick up in job creation, strong foreign demand for US equities and a more aggressive stance from the Fed. They are predicting 1.50 EUR within 12-months.

The US$ is weaker in the O/N trading session. Currently, it is lower against 13 of the 16 most actively traded currencies in an ‘orderly’ session.

Yesterday’s US data did not bring forth any real surprises. Even with US retail sales slightly missing expectations (+0.4% vs. +0.5%) the underlying details were positive. The core-component (ex-autos and energy) posted another decent gain (+0.8%), suggesting that the improvements in the labor force are finally having an affect on consumer spending. Analysts note that the gains were relatively broad based with gas station sales up +2.6%, building material +2.2%, electronics +2.1% and furniture +3.6%. It’s worth noting that February’s results were also revised higher to +1.1%.

The Fed’s Beige Book reported that the US economy continues to expand at a ‘moderate’ pace from mid-February through March. They indicated that the weak job market was also doing better, with hiring still strong in manufacturing (this sector continues to lead the gains). It’s worth noting that the higher costs for commodities and raw materials led some companies to raise prices, but, the ability to pass on higher prices varied across regions. With wage pressures subdued, there was little sign of inflation. We get PPI this morning and CPI tomorrow, analysts expect rising manufacturing prices to drive PPI higher, while steady retail prices weigh on CPI growth.

The USD is lower against the EUR +0.21%, GBP +0.44%, CHF +0.36% and JPY +0.69%. The commodity currencies are stronger this morning, CAD +0.10% and AUD +0.18%.

The BoC’s MPR had little effect directly on the loonie yesterday. The details show that policy makers expect to gradually hike interest rates through 2013, while warning that the strong CAD could hurt exports and act as a drag on growth, as well as put added downward pressure on inflation through cheaper imports. Earlier this week, Governor Carney kept rates on hold at +1%. Their new forecast for the loonie is 0.9700.

Overall, the BoC is less concerned about global and US risk as it focuses on the strong dollar. Governor Carney has been trying to talk the CAD down. The BoC statement was less hawkish than it could have been, and suggests the strong potential for policy neutrality for an extended ‘period-of-time’. It’s worth noting that with only 10% of Canadian exports going to emerging markets, Canada is not likely to benefit from the current commodity boom (0.9626).

This month the Aussie dollar has been leading the G10 rally, however, the currency has stalled versus all its major trading partners, especially the yen, in the O/N session after the MAS stepped up its fight against inflation and the BRIC leaders said rising commodity prices posed a threat to growth. The MAS, in its third tightening of policy this year, are combating inflation and their actions appear to be spurring risk-aversion and pressurizing commodity and growth sensitive currencies.

The market weakness in commodities and emerging market equities over the last two trading sessions certainly has not supported growth sensitive currencies. Depending on how risk appetite pans out, these pull backs may end up being a good buying opportunity. With Japan’s loose monetary policy, the yen is expected to continue to weaken further with Japan lagging any significant recovery.

Australian yields are still the highest in the G10 and continue to attract regional investor’s en masse. The expected mix of trade surpluses and rising capital inflows should provide support for the currency on these pullbacks (1.0503).

Crude is little changed in the O/N session ($107.04 -7c). The growing expectation among investors that the Fed will lag other Cbanks in tightening monetary policy is creating a supportive backdrop for commodities, keeping the dollar in check and creating a more favorable investment environment. After solidifying its biggest two-day loss in 14-months, the market found some technical traction, believing this week’s early rout was overdone. Also aiding crude prices was the magnitude of the gasoline drawdown last week, the largest in 13-years.

Last week’s EIA report showed crude stocks climbed +1.60m barrels to +359.3m, remaining above the upper limit of the average range for this time of year. On the flip side, gas supplies plummeted-7m barrels and are near the lower limit of the average range. Oil refinery inputs averaged +14.0m barrels per day during the week, which were-354k barrels per day below the previous week’s average as refineries operated at +81.4% of capacity.

The IEA said it maintains its 2011 global oil demand growth forecast but noted that the high oil prices are beginning to dent demand growth based on its preliminary data for January and February. Both the IEA and IMF have said that prices above the $100 watermark are beginning to hurt the global economy. Even Goldman is recommending to investors to take profit on the one directional commodity trades.

Technically, price movements have been excessive with investors building in a high insurance premium because of the geopolitical situation. The reality is that commodity price shocks have emerged as a new risk to the global economy’s expansion and why the IMF cites the world economy is more likely to disappoint than to beat expectations. However, we have a market condition that was way overbought and in danger of giving up ground with the bears increasing their negative rhetoric.

Gold prices have recovered from their biggest one day drop in a month as the dollar retreats amid expectations that Bernanke and Co. will maintain its accommodative monetary policy in the medium term. Gold as a non-yielding asset has a higher opportunity cost when interest rates rise.

The commodity plunged earlier this week on the back of the reduced economic growth forecasts from the IMF and the easing of inflationary pressures. Goldman indicated that if one owned commodities, the risks outweigh any further potential gain. This had been a catalyst for the bulls to lighten up their long positions. Regardless of event and geopolitical risk, the general dollar malaise against its major G7 trading partners will eventually support commodities. The dollar tends to trade inversely with the price of the commodity. The metal has jumped +27% in the past year.

The metals bull-run is far from over with investors continuing to look to buy the commodity on dips. Any price pullbacks are viewed as favorable opportunities for investors to continue to diversify into safe-haven assets, especially metal being used as a store of value ($1,462 +$7.10).

The Nikkei closed at 9,653 up+13. The DAX index in Europe was at 7,145 down-23; the FTSE (UK) currently is 5,975 down-34. The early call for the open of key US indices is lower. The US 10-year eased 4bp yesterday (3.46%) and is little changed in the O/N session.

Treasuries gained as global equities headed lower, increasing investors risk aversion and boosting the demand for the safety of US government debt. Investors are beginning to realizing that the global recovery is not necessarily a ‘one-way move up, but will remain inconsistent’. Rumors of analysts revising US GDP lower (April 28) is also providing some support.

The US government sold $21b in 10-year notes yesterday and will sell $13b in 30-year bonds today. Yesterday’s 10-year auction was not well received, tailing +1.2bp with a yield of 3.494%. The bid-to-cover ratio was 3.13 compared with an average of 3.07 for the previous eight sales. The indirect bid was 42.4% below the 51.2% average.

Expect dealers to cheapen the curve ahead of the long bond issue to take make room for supply.

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Let The Debate Begin!

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By Mike Conlon | April 14, 2011

Yesterday President Obama came out with a speech regarding the debate that is about to heat up in Washington DC and define the economic course that the US will pursue moving forward. The obvious problem is the US Federal deficit, which is going to bankrupt this country (worse than it already is!) if nothing is done about it.

House Republicans have put forth a comprehensive plan that has both plusses and minuses, and will likely serve as a starting point for negotiations. However, nothing in yesterday’s speech outlined a credible plan to move tackle our problems, so the markets have become fearful of what could happen.

The near-term debate is going to be over what to do about the debt ceiling; if it is not raised or if cut-backs aren’t made, then we could be facing a funding problem. The timing of this essentially coincides with the end of QE2, which has pushed markets higher since its inception at the end of last year.

How the markets will react to both situations is uncertain at this point in time, but the markets are a discounting mechanism so at some point this all needs to be factored in. Perhaps that’s what we’ve been seeing over the last few days of selling.

This morning, both stocks and commodities are lower to start the day as we await the initial jobless claims numbers and the PPI data.

In the forex market:

Aussie (AUD): The Aussie is mostly lower on risk aversion though not by much as it is protected from shorting by its interest rate differential which makes it cost prohibitive to do so.

Kiwi (NZD): The Kiwi moved to a 5-month high after a successful bond auction increased demand for the currency. The Kiwi is tracking slightly higher despite the early risk aversion in the market. (Click chart to enlarge)

Loonie (CAD): The Loonie is mostly lower as its close ties to the US and a declining oil price to start the day have induced selling.

Euro (EUR): There’s no appreciable news out of the Euro zone this morning, so it is trading on its anti-Dollar sentiment which weakened it to start the day though it may reverse as US stocks open. (Click chart to enlarge)

Pound (GBP): The Pound is trading mostly higher after consumer confidence figures came in higher than expected after reaching record lows.

Dollar (USD): The Dollar is mixed as it is receiving the benefit of the flight to safety trade, despite PPI data which just came in at .7% and initial jobless claims that came in higher than expected at 412K. Not a good sign for the economy, but perhaps good for Fed watchers.

Yen (JPY): The Yen is stronger across the board as the Dollar shed some of its safe haven status and the nuclear threat is still a major problem. Yet there are still estimates coming in that predict an economic rebound.

Today’s data in the US shows economic weakness which the Fed is praying may just be an anomaly and a re-start of an economic downturn. The road to stagflation is one the Fed was hoping to avoid, though misguided policies and unintended consequences may be both the cause and the effect.

This bring us back to the fiscal policy debateâ€"if we don’t do something about fiscal policy, then the Fed will attempt to smooth things over with monetary policy. Let’s face it: 100% of the people enjoy a free lunch.

Until we get some real leadership out of Washington DC, we are going to continue to head closer to the cliff at warp speed. I hope you have a parachute!

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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What’s Next for the Yen?

After the G7 intervened in forex markets last month, the Yen fell dramatically and bearishness spiked in line with my prediction. Over the last week, however, the Yen appears to have bottomed out and is now starting to claw back some its losses. One has to wonder: is the Yen heading back towards record highs or will it peak soon and resume its decline?

Some analysts have ascribed tremendous influence to the G7, since the Yen fell by a whopping 5% following its intervention. From a mathematical standpoint, however, it would be virtually impossible or the G7 to single-handedly depress the Yen. That’s because the Yen holdings of G7 Central Banks are decidedly small. For example, the Fed holds only $14 Billion in Yen-denominated assets (compared to the Bank of Japan’s $800+ Billion in Dollar assets), of which it deployed only $600 million towards the Yen intervention effort. Even if the Bank of Japan is covertly intervened (by printing money and advancing it to other Central Banks), its efforts would still pale in comparison to overall Yen exchanges. Trading in the USD/JPY pair alone accounts for an estimated $570 Billion per day. Thus, given the minuscule amounts in question, it would be unfeasible for the Central Banks alone to move the Yen.

Instead, I think that speculators â€" which were responsible for the Yen’s spike to begin with â€" purposefully decided to stack their chips on the side of the G7. Given the unprecedented nature of the intervention, and the resolute way in which it was carried out, it would certainly seem foolish to bet against it in the short-term.  In fact, the consensus is that, “Investors are confident that the G7 won’t let the yen go below 80 versus the dollar again.” Still, this notion implies that if speculators change their minds and are determined to bet on the Yen, the G7 will be virtually powerless to block their efforts.

For now, speculators lack any reason to bet on the Yen. Aside from the persistent financial uncertainty that has buttressed the Yen since the the 2008 credit crisis, almost all other forces are Yen-negative. First, the crisis in Japan has yet to abate, with this week bringing a fresh aftershock and an upgrading of the seriousness of the nuclear situation. The hit to GDP will be significant, and a chunk of stock market equity has been permanently destroyed.

Thus, foreign institutional interest in Yen assets â€" which initially surged as investors swooped in following the 20% drop in the Nikkei 225 average â€" has probably peaked. The Bank of Japan will probably continue to flood the markets with Yen, and the government of Japan will need to issue a large amount of debt in order to pay for the rebuilding effort. Given Japan’s already weak fiscal situation, it seems unlikely that it can count on foreign sources of funding.

Even worse for the Yen is that Japanese retail traders (which account for 30% of Yen trading) seem to have shifted to betting against it. They are now driving a revival in the carry trade, prompting the Yen to fall to a one-year low against the Euro (helped by the recent ECB rate hike) and a multi-year low against the Australian Dollar. “Data from the Commodity and Futures Trading Commission (CFTC) showed speculators went net short on the yen for the first time in six weeks and by the biggest margin since May 2010 at a net 43,231 contracts in the week to April 5.”

It’s certainly possible that investors will take profits from the the Yen’s fall, and in fact, the recent correction suggests that this is already taking place. However, the markets will almost certainly remain wary of pushing things too far, lest they trigger another G7 intervention. In this way, Yen weakness should become self-fulfilling, since speculators can short with the confidence that another squeeze is unlikely, and simply sit back and collect interest.

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Just Ignore It!

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By Mike Conlon | April 12, 2011

That was the plan of the BOE with regard to inflation in the UK, and this morning it looks like that plan may be working. CPI data came in this morning showing a gain of 4% vs. an expectation of 4.4%, which means that in fact the lack of government spending due to the austerity measures may be providing relief from higher prices.

However, it must be noted that 4% is still pretty high, and nearly twice the BOE target rate. Some other data from the UK shoed that retails sales figures have slipped slightly and the trade deficit came in slightly lower than expected.

A situation that cannot be ignored however is the nuclear one in Japan, and officials are out saying that the extent of the damage may be worse than originally thought. In addition, the nuclear disaster level has been raised to that of the Chernobyl disaster many years ago.

Another policy-maker not content to put his head in the sand is RBNZ Governor Bollard, who came out and said that inflation may be rising to the point where a change in monetary policy would be necessary. This means potential higher rates.

Canada is going to announce its rate decision later this morning and is expected to leave rates unchanged at 1%. Pay attention to the accompanying policy statement, as it may reveal more about the decision.

Yesterday’s markets were marked by a sell-off in commodities, particularly oil which traded lower by a close to $5. Oil is slightly higher this morning to $109, after trading down from $113 yesterday. Metals were somewhat weaker, though not to the extent of oil. Stocks finished lower and this morning looks like a continuation of selling to start the day.

In the forex market:

Aussie (AUD): The Aussie is mostly lower as risk aversion is present to start the day after the Japanese heightened nuclear disaster levels.

Kiwi (NZD): The Kiwi is higher despite the risk in the market as RBNZ Governor Bollard came out and said that inflation may become a problem and that the Central bank may need to act to curb it. Rates were lowered at the last meeting in response to the earthquake that devastated NZ’s second-largest city.

Loonie (CAD): The Loonie is lower across the board ahead of this morning’s rate decision which is expected to leave rates unchanged at 1%. Higher oil prices have been driving the Loonie to 2-year highs so there may be some dovish comments to accompany the decision to try to jawbone the currency lower. (Click chart to enlarge)

Euro (EUR): The Euro is a mixed bag this morning, balancing between individual fundamentals and anti-Dollar sentiment. German CPI data came in slightly higher than expected, but economic sentiment figures came in worse than expected, posting a reading of 7.6 vs. an expectation of 11.3. The current situation figures were better than expected though, essentially canceling each other out.

Pound (GBP): The Pound is lower across the board as CPI data came in lower than expected, perhaps providing relief to the BOE who chose to ignore the inflation and let it go away on its own. Well not really, government austerity measures and a lack of spending had something to do with it, but whether this is a start of a new trend lower or just an aberration remains to be seen. (Click chart to enlarge)

Dollar (USD): The Dollar is mixed to start the day, as there is relatively little news that would swing it one way or another. Expect it to trade on correlations today with oil and stocks.

Yen (JPY): The Yen is mostly higher as the threats of radiation from the nuclear disaster have been raised. In addition, the government admitted that the costs to the economy may be more than previously thought. Not sure what they were thinking originally.

So it looks like the BOE is getting bailed out today with the affirmation of the lack of policy response, but remember, one reading does not a trend make. Inflation is still high at 4% and unless it continues to trend lower, the BOE is not off the hook yet.

Last week’s run-up in oil and commodity prices was tested yesterday as reports are starting to come out that the commodity story may be over, which tells me that indeed it can persist and make new highs. Call me a skeptic, but when people start beginning to call tops usually tells me that we’re not there yet.

So the major theme in the global marketplace is the week Dollar, and until the Fed acts to change that I don’t see any reason to own the Dollar at this point. However, I will be quick to run through that door should a policy shift or another global risk event occur.

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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Dollar remains Fools Gold

Despite all the event and geopolitical concerns, there remains a healthy tolerance for risk in the market. Investors believe that the EUR is less exposed to a decline in risk appetite. Trichet and company’s hawkishness, mixed with the Fed’s dovish response to higher oil prices continue to make the EUR an increasingly attractive alternative to the dollar.

The danger to this morning’s US retail sales number, the market is assuming it will disappoint, could increase global risk aversion, contributing to additional carry trade unwind amongst the G10 currencies. This afternoon we have the Fed’s beige book, there, the focus will be on ‘any evidence that US retailers are increasingly willing to pass on higher input prices to the consumers’.

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

The market preconception is that the divergence of global yields will underpin the value of the dollar, mind you, the weaker data is not helping either. Yesterday’s US trade gap narrowed in February to -$45.76b, but by less than expected. The underlying details were weaker, as the pace of decline in imports outpaced that of exports. The nominal, dollar-based deficit, which includes both price and volume effects, narrowed -1.4%, m/m, to $45.8b in February, as the trade deficit in goods shrunk by -1.6% and the trade surplus in services expanded +1.9%. After five straight months of gains, exports contracted -1.4%. The ‘real’ trade deficit in goods remained virtually unchanged, narrowing -0.1% to $49.5b, its widest level since December. This is what matters to GDP, and carries negative implications for the first quarter.

The USD is lower against the EUR +0.16% and higher against GBP -0.02%, CHF -0.04% and JPY -0.48%. The commodity currencies are stronger this morning, CAD +0.19% and AUD +0.50%.

As expected, the BoC stood pat on rates yesterday (+1%). In his communiqué, Governor Carney raised the Bank’s growth forecast for 2011 to +2.9% from +2.4% and predicted that the economy will now return to full capacity in mid 2012, six-months earlier than originally forecasted. Again, he reiterated that the currency could weigh on growth and inflation, citing the loonie as a headwind to growth ‘twice’ in his statement. He repeated the line that a reduction in monetary stimulus would have to be ‘carefully considered’. The market had been expecting it to be replaced with a warning of a reduction in stimulus.

Overall, the BoC is less concerned about global and US risk as it focuses on the strong dollar. Governor Carney is trying to talk the dollar down. The BoC statement followed the trade numbers that are driving the quarterly inflation-adjusted volume-based trade deficit to another record high as export volumes fell -5.2%, m/m, and by more than the -4.3% m/m decline in import volumes.

The statement was less hawkish than it could have been, and suggests the strong potential for policy neutrality for an extended ‘period-of-time’. Softer commodity prices have investors looking to book profits (0.9620).

This month the Aussie has been leading the G10 rally, showing no lasting ill-effects from the decision by the PBoC to hike policy rates last week. Now that the market has been able to digest Japanese event risk and concentrated on global fundamentals has the AUD rising in the O/N session. Signs of global growth is boosting the demand for higher-yielding assets. The currency has snapped a two-day drop versus the yen after industry reports showed Australian consumer confidence rebounded last month (105.3).

The market weakness in commodities and emerging market equities over the last two trading sessions certainly has not supported growth sensitive currencies. Depending on how risk appetite pans out, these pull backs may end up being a good buying opportunity. With Japan’s loose monetary policy, the yen is expected to continue to weaken further with Japan lagging any significant recovery.

Australian yields are still the highest in the G10 and continue to attract regional investor’s en masse. The expected mix of trade surpluses and rising capital inflows will provide support for the currency on these pullbacks (1.0484).

Crude is lower in the O/N session ($106.19 -6c). Oil prices collapsed over the last two trading sessions, solidifying its biggest two-day loss in 14-months. Both the IEA and IMF have said that prices above the $100 watermark are beginning to hurt the global economy. Even Goldman is recommending to investors to take profit on the one directional commodity trades.

Earlier this week the IMF cut US and Japan’s growth rate forecasts and the IEA reported signs of an oil-demand ‘slowdown’ in its monthly report has the black stuff retreating-6% on the week. Fundamentally, current prices aren’t justified by the supply and demand scenario. Technically, price movements have been excessive with investors building in a high insurance premium because of the geopolitical situation. The reality is that commodity price shocks have emerged as a new risk to the global economy’s expansion and why the IMF cites the world economy is more likely to disappoint than to beat expectations.

Last week’s EIA report showed crude stocks climbing +2m barrels. The market expected an increase of only +1.3m. On the flip side, gas supplies decreased-400k barrels, while distillates supplies (heating oil and diesel) increased +200k barrels.

The naysayers believe that the recent MENA events will make it unlikely that investors will see a ‘swift normalization’ of crude-oil production in the region. However, we have a market condition that was way overbought and in danger of giving up more ground with the bears increasing their negative rhetoric.

After rallying to another new record this week, gold prices have softened as investors continue to take profit off the table. The commodity slid by more than-1% yesterday, mirroring the sharp decline of other commodity prices and this despite the correlation between the yellow metal and the dollar index reaching it’s most negative in nearly three-months.

The commodity’s downfall has been sparked by the reduced economic growth forecasts from the IMF and the easing of inflationary pressures. Goldman indicated that if one owned commodities, the risks outweigh any further potential gain. This has been a catalyst for the bulls to lighten up their long positions. Regardless of event and geopolitical risk, the general dollar malaise against its major G7 trading partners will eventually support commodities. The dollar tends to trade inversely with the price of the commodity. The metal has jumped +27% in the past year.

The metals bull-run is far from over with investors continuing to look to buy the commodity on dips. Any price pullbacks are viewed as favorable opportunities for investors to continue to diversify into safe-haven assets, especially metal being used as a store of value ($1,457 +$4.30).

The Nikkei closed at 9,641 up+86. The DAX index in Europe was at 7,145 up+42; the FTSE (UK) currently is 6,006 up+42. The early call for the open of key US indices is higher. The US 10-year eased 7bp yesterday (3.50%) and is little changed in the O/N session.

Treasuries gained for the first time in three days after a nuclear warning and earthquakes in Japan sent global equities lower, increasing investors risk aversion and boosting the demand for the safety of US government debt. Investors are beginning to realizing that the global recovery is not necessarily a ‘one-way move up, but will remain inconsistent’.

The US government will sell $21b in 10-year notes today and $13b in 30-year bonds tomorrow. Yesterday’s $32b 3-year issue was well received, stopping at +0.6bp through the screens at +1.28%. Indirect bidders took +33.7% of the issue, direct took +8.9% compared to an average of +13.9%. The auction had a 3.25 bid-to-cover ratio compared to an average cover of 3.07.

Expect dealers to cheapen the curve ahead of the issue to take down supply.

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Interview with Mike Kulej of FXMadness: “Trading the News is Akin to Gambling”

1. I am intrigued by the fact that your blog is deliberately focused on
“the exciting world of Forex outside the dollar.” Is there a strategic reason for
this choice?

At the time when I started the blog, everybody was talking about the Euro, the Pound, the Yen, so there was a lot of information available regarding the so-called “majors”. In principle, those are all of the main Dollar pairs. However, there were far fewer sources covering the crosses and exotic pairs. For example, everybody has an opinion about the EUR-USD, but not the NZD-CHF or the GBP-AUD. I wanted to offer information not easily found elsewhere and increase awareness that there are opportunities outside the US Dollar. Besides, that is what I trade…

2. What’s the most undervalued/under-appreciated currency?

Among the most popular currencies, I feel that the British Pound is the most undervalued, followed but the New Zealand Dollar. The Canadian Dollar also has plenty of appreciation left. Within exotics the Indian Rupee, the Russian Ruble and the Polish Zloty come to mind.

3. Could you briefly explain your approach to analyzing and trading in the
forex markets. Do you prefer technical or fundamental analysis, or a
combination of both?

My analyses include both fundamental and technical views. After all, it is the fundamentals that drive the markets, forcing big money to flow in and out of given currency. Unfortunately, they are very imprecise, and not suitable for active trading. Acting on fundamentals alone is more like investing. Trading demands specific conditions to be met, for both entries and exits and that is offered by technical analysis. My buy and sell decisions are made based on technical factors, with awareness of fundamental conditions.

4. It is always refreshing to read another trader/blogger discourage the
use
of extreme leverage, especially given that it remains one of the main
selling points that brokers use to attract potential customers. Can you
elaborate on your philosophy of leverage, and perhaps offer some advice in
this regard to novice traders?

Yes, brokers overplay the availability of leverage. They manage to point out advantages, but not the risks. Leverage itself will not make anybody better trader, it will only magnify losses and gains. In addition, trading with high leverage adds to the already highly emotional nature of this activity. It is natural that a trader wants to make as much money as possible, but before using leverage, one should prove it to him/herself that the account is actually growing. I would suggest trading without leverage, at 1:1 for some time, at least 50 or more trades. If at this point the account shows gains, some form of leverage might be employed. Somewhere along the line a trader will discover the “right” leverage for own personality, one that will allow to take advantage of this tool at a correct emotional level.
With me, leverage changes depending on the time frame employed for any given trade. If I use daily/weekly charts and expect the trade to last weeks, than no leverage is employed. For trades based on 4h and 1h charts, the leverage is either 2:1 or 4:1. Vast majority of my trades are done on at these levels. For very short-term transactions, using 5m charts, for example, my leverage can go as high as 10:1, but this is rare.
People often overlook that using low leverage per trade allows opening many different trades at the same time in one account. This diminishes dependence on any one trade. As long as the trades are not too correlated (like shorting all Yen pairs at the same time), using low leverage allows for diversification within an account.

5. What do you think about the recent report by the Saint Louis Fed [
http://research.stlouisfed.org/wp/2011/2011-001.pdf] that concluded that
the
power/profitability of technical analysis in the forex markets is steadily
declining? Do you think that this should serve as a warning to retail
traders that they need to consider alternative strategies, or that they
simply need to work harder?

This report focuses primarily on trend identification analysis, with moving averages in focus. For the longest time currencies had a reputation of instruments that trend very well, meaning the main trends last a long time and are relatively gradual. Under these circumstances, moving averages can be simple, yet effective, trading tools and this is what the report covers. It is just a matter of finding “correct” MA, which is always easier said than done.
Trend following strategies are typically used by the biggest trading entities, because their size forces them to trade that way. That was obviously very difficult during the last few years, as currency trends changed from relatively steady to very choppy. The Japanese Yen, for example, had been getting steadily weaker for years. In summer of 2007, this trend became shakier, but prevailed. Many trend following programs were stopped out, so they had to adjust to a little more volatile conditions, by making stops wider. However, that was not enough for what came next year, during the 2008 crisis. Bigger price swings, losses and positions in opposite direction had to have even larger stops to account for prevailing volatility. Then the sharp corrections in early 2009 likely triggered even those extended stops. Comparing to those times, current environment is relatively quiet, so trend following systems are doing probably better and, who knows, might work just fine for years to come. It will be interesting to see similar report in, say, 10 years.
Incidentally, all types of technical analysis will have good and bad times. Does not matter what indicator, pattern or charting method is used, nothing is 100% correct. The trick is to not to get discouraged during losing periods, which are sure to happen.

6. You revealed that some of your biggest trading profits were netted
around
the peak of the credit crisis. Were these trades based on fundamental
factors, technical factors, or simply instinct?

At that time fundamental analysis were just about worthless and amounted to not much more than guessing. When reading opinions and predictions by some of the biggest names in the business at that time, we can see just how diverse and contradicting they were. Those trades were technical, using large magnitude charts, mostly weekly. The strategies were common, only that they do not happen often on large time scales. Of course, there was an element of “luck”, in a sense that I cannot replicate these results at will â€" right set of market conditions must be present, including extreme volatility. After all, how often does GBP-JPY move 2000 pips in one day?

7. On a related note, you seem to enjoy volatility. Does volatility make
trading more profitable, or simply more exciting? Do you have to adjust
your
trading strategy when the markets are especially choppy?

It depends on what type of volatility we are experiencing. When markets are changing direction without a rhyme or reason, I try to stay away. On the other hand, volatility expressed by an increased size in price swings after a period of consolidation is my friend. Most of my strategies depend on this type of volatility and yes, that is what makes my trading profitable. More exciting? To a degree, yes, although I try to keep emotions to minimum. But realistically, whom are we kidding? Every time real money is on the line, emotions are involved to some degree. The key is to control them.

8. You’ve alluded to the possibility that a Tobin tax (on all forex
transactions) could one day be implemented. As a trader, you are clearly
against this. Still, do you think that this could serve any positive
economic function? Do you think Central Banks and policymakers ought to
pay
any attention (and react accordingly) to exchange rates?

The Tobin tax is supposed to fund global environmental issues. Great idea but why single out this particular segment of population? Who would have a say in how and where to spend the funds? Can we envision the level of cooperation between countries, which would be necessary to implement any changes? Besides, a concept of a worldwide tax for any reason is simply too radical.
As far as central banks go, it is their function to pay attention to general financial conditions, which includes exchange rates of domestic currency. All of their decisions effect exchange rates intended or not. Central banks should be treated as another player in the market. If the currency is floating, the central bank has every right to “react accordingly”. Their success rate is not much better than any other group of market participants. At least they are a “known quantity”, unlike central banks of countries, which do not allow floating rates.

9. After rising dramatically in the wake of the natural disasters, the
Japanese Yen appears to have fallen back. Even though you are not
currently
trading the USD/JPY, would you care to offer a short-term forecast?

Funny you should mention the USD-JPY. I had not traded it in a long time, other Yen crosses simply offer better opportunities â€" they move more. Recently, though, I covered a trade in this pair on the blog
http://fxmadness.com/2011/03/20/general/long-term-yen-charts/ . It created a very clear, easy to spot, high probability trading set up, and so I took it.
In my opinion, the USD-JPY has made a major bottom and I expect to see 90.00 within the next 1-2 months and 100.00 maybe before the end of the year. Anything beyond that will have to be decided as the price unfolds and new important fundamentals emerge.

10. How does the possibility of interest rate hikes bear on your current
trading strategy? Will you deliberately exit any relevant positions you on
days that interest rate decisions are scheduled?

When trading short-term time frames, I avoid taking positions before major announcements. And yes, if in a trade, I often exit before these events, regardless of profit or loss. Currently the news releases, which have the biggest impact, are rate decisions by FED, RBA, RBNZ and BoC (Bank of Canada), as well as monthly employment data from these countries. These are the most volatile and unpredictable. This list changes from time to time. As a rule, I do not trade news releases with the intention to capitalize on them, for example getting in a position before the NFP data and trying to exploit what happens after. I find it too akin to gambling.

11. Finally, what advice do you have for forex traders that want to beat
the
market in these uncertain times?

This may sound old and worn out, but always use stops. You will not get mega rich in a day, yet can go broke in one if, a stop is not in place… Preserve your capital.

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Slow Start To The Week!

« Shut It Down! | Home

By Mike Conlon | April 11, 2011

This week is starting out slowly as there is little news today to warrant any excessive volatility or trend disruptions. This may be a good thing as after Friday’s major moves higher in commodities and the resulting Dollar weakness, a quick pause to re-evaluate may be exactly what this market needs.

Here’s what we do know this morning: Chinese exports came in better than expected overnight giving them a trade surplus vs. an expected trade deficit. I guess that peg to the Dollar really helped out!Over the weekend, the US government was able to come to a compromise to keep the government operatingâ€"for now. Quickly the conversation is going to switch to the debt ceiling which needs to be raised if we want to keep doubling down, or perhaps this is just another political game to be played.Japanese machine orders fell and the aftershocks keep coming as earthquake after earthquake continues to pound the island nation. A mixed reading of industrial production figures in the Euro zone has led to some minor weakness.

Later today, two noted Fed Doves (inflation deniers) Yellen and Dudley will be speaking. The only risk here is that a deviation from their noted dovish stances could belie a shift on the FOMC. This is highly doubtful.

Meanwhile, oil has “pulled back” to $112, and gold to $1470. US stocks are set to open higher, and Europe is mixed ahead data due out later this week.

But make no mistake about it; Dollar weakness is driving global markets higher, as the Dollar index has put in a 17-month low. How much lower the Dollar can go without disrupting economies abroad remains to be seen.

In the forex market:

Aussie (AUD): The Aussie is marginally lower this morning with no news to guide it higher. Commodities have pulled back a bit so the US dollar is strengthening some, but this could just be a cat-cat bounce. Consumer confidence figures due out on Wednesday highlight the extent of the news form down under.

Kiwi (NZD): The Kiwi has been moving higher very quietly as the re-building efforts from the earthquake are starting to add to the pick-up in economic activity. The Kiwi just broke its 2011 high vs. USD. (Click chart to enlarge)

Loonie (CAD): The Loonie is pulling back a little as oil is now trading at $111.50. This comes ahead of tomorrow’s BOC rate decision where the expectation is that rates will be left unchanged at 1%.

Euro (EUR): The Euro is starting the day lower as mixed industrial production figures do little to affect the Euro one way or the other. What is affecting the Euro this morning is a wee bit of US dollar strength, as oil prices retreat. The Euro fell just short of reaching 1.45 vs. USD. (Click chart to enlarge)

Pound (GBP): The Pound is mixed this morning ahead of tomorrow’s CPI report which is expected to show inflation still a problem at 4.4%. Should inflation subside in any meaningful way, then the BOE may be afforded more time to allow fiscal policy reductions to work, rather than having to do it through monetary policy. UK jobless claims are due out on Wednesday.

Dollar (USD): The Dollar appears to be doing a little “dead-cat bounce” here, as oil prices have pulled back after the risk of being short over the weekend was navigated. Fed doves will speak today but don’t expect a change of heart with regard to policy stance.

Yen (JPY): Aftershock after aftershock keeps happening in Japan which has heightened the risk that this nuclear situation could get worse. While economic fundamentals are bound to be moribund in the short-term, the long-term prospects for growth appear grounded due to the re-building that will take place.

There are many factors contributing to the global economy that have had various push-pull effects on different markets. But the one underlying theme that continues to persist is Dollar weakness.

While economic data this week won’t be as telling here in the US, both the UK and Canada have news that could be market moving. But overall, the weak US dollar trend is still intact.

However, if you are not already short the US dollar, it may be difficult to get in here, so wait for pullbacks to get a better low-risk entry. And of course keep an eye on the news to see if any other region’s fundamentals begin to look as bad as the US.

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!

Tags: account, AUD, Aussie, blog, BOE, cad, canada, commodities, course, currenc, currency, currency market, currency trading, data, decision, dollar, dow, economic, economy, EUR, Euro, Europe, fed, forex, forex market, forextrading, free, fundamental, fx, fxedu, gbp, gold, Il, index, Japan, jpy, Kiwi, live, loonie, lower, market, Mike Conlon, news, nzd, oil, pound, practice, practice account, rate, rate decision, RSI, short, ssi, stock, stocks, time, trade, trend, USD, Yen

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Dollar not Sick it’s Terminal

This week the dollar has had the classic opportunity to rally aggressively. Global risk appetite has subsided, commodity currencies have fallen and investors were willing to take profit. Instead, we have witnessed only a feeble attempt to rise. The dollar is more than sick, it’s terminal.

With the Fed expected to now trail all other Cbanks when it comes to tightening, is putting the dollar near the bottom of the G10 carry trade league and up there with the classic funding currencies. Even the hawks are unable to save their currency from the abyss.

Expect the fears of a debt default and reserve diversification to weigh heavily on the global ‘reserve’ currency. Investors are demanding higher yield to account for that risk and QE2 has done a good job in keeping them artificially low. Asian Cbanks are keen to diversify their dollar denominated reserves into other currencies like the EUR, CAD or other higher yielding currencies.

The US$ is mixed in the O/N trading session. Currently, it is lower against 10 of the 16 most actively traded currencies in an ‘whippy’ session.

Market action has been intense in the overnight session, very different from yesterday’s anemic trading range. The Japanese government have lifted their atomic alert from level 5 to level 7 (on par with Chernobyl), which has caused the ‘carry trades’ to unwind sharply. The flight to safety has also helped the CHF to outperform. The ‘carry’ trade to date has had a strong first half of the month.

The USD is higher against the EUR -0.01%, GBP -0.62% and lower against CHF +0.45% and JPY +0.37%. The commodity currencies are weaker this morning, CAD -0.10% and AUD -0.21%.

There was a real lack of enthusiasm in yesterday’s session, the loonie has been confined to a tight, non-directional range with export offers willing to sell on dollar rallies as the market waits for this mornings North American trade numbers and the BoC’s rate decision, where Governor Carney is expected to remain on hold (+1%). Last month the currency appreciated +3.3% outright. Unless this morning decision or rhetoric brings forth any surprises, this growth sensitive currency will continue to be in demand on dollar rallies.

With ‘carry’ historically the go to trade this month, has investors looking to buy the currency on pullbacks. The loonie is being supported by its fundamentals, a sound financial system and a strong job environment. Now its up to Carney to give investors some direction, futures dealers are already pricing in rate hikes in the second half of this year (0.9572).

This month the Aussie has been leading the G10 rally, showing no lasting ill-effects from the decision by the PBoC to hike policy rates last week. Last night the AUD met a stumbling block, falling the most in a month against the yen, after Japan raised the severity rating at the Dai-Ichi nuclear power plant, damping demand for higher-yielding assets. On a technical level, the lemming ‘carry’ trade has rallied too quickly and requires a pull back. The market weakness in commodities and emerging market equities over the last two trading sessions certainly does not support growth sensitive currencies. Depending on how risk appetite pans out in this morning’s session, these pull backs may end up being a good buying opportunity. With Japan’s loose monetary policy, the yen is expected to continue to weaken further with Japan lagging any significant recovery.

Australian yields are still the highest in the G10 and continue to attract regional investor’s en masse. The expected mix of trade surpluses and rising capital inflows will provide support for the currency on these pullbacks (1.0477).

Crude is lower in the O/N session ($109.84 -6c). Oil prices lost its sting in the tail yesterday after the IMF cut US and Japan’s growth rate forecasts and retreated from the 32-month highs. Prices were further pressurized by the African Union stating that Gadaffi agreed to a cease-fire plan, fueling speculation that exports from the North African nation may recover.

Fundamentally, current prices aren’t justified by the supply-and-demand scenario. Technically, price movements have been excessive with investors building in a high insurance premium because of the geopolitical situation. The reality is that commodity price shocks have emerged as a new risk to the global economy’s expansion and why the IMF cites the world economy is more likely to disappoint than to beat expectations.

Last week’s EIA report showed crude stocks climbing +2m barrels. The market expected an increase of only +1.3m. On the flip side, gas supplies decreased-400k barrels, while distillates supplies (heating oil and diesel) increased +200k barrels.

The naysayers believe that the recent MENA events will make it unlikely that investors will see a ‘swift normalization’ of crude-oil production in the region. For the time being the market will remain better buyers on pullbacks.

After rallying to another new record gold prices have softened as investors took some profit off the table. The possibility that Gaddafi may adhere to an African peace plan that may lead to a cease-fire with rebels is also eroding demand for gold as an investment haven. Regardless of event and geopolitical risk, the general dollar malaise against its major G7 trading partners will support commodities. The dollar tends to trade inversely with the price of the commodity. The metal has jumped +29% in the past year.

Despite the softening of prices, the commodity preserved its tenth quarterly gain last quarter, its longest winning streak in over 35-years, as low interest rates and event risk provide support. It’s difficult to find a reason not to own some of the commodity.

The metals bull-run is far from over with investors continuing to look to buy the commodity on dips. Any price pullbacks are viewed as favorable opportunities for investors to continue to diversify into safe-haven assets, especially metal being used as a store of value ($1,464 -$3.70).

The Nikkei closed at 9,555 down-164. The DAX index in Europe was at 7,152 down-53; the FTSE (UK) currently is 6,006 down-47. The early call for the open of key US indices is lower. The US 10-year backed up 2bp yesterday (3.57%) and eased 3bp in the O/N session (3.54%).

The market had given up some of its risk premium that was accumulated ahead of a potential US government shutdown last week. The long end of the US curve is underperforming as investors prepare to take down $66b in new supply this week. The market seems to be weary of the possibility that the Fed will end its ‘easy money policies’ may send yields still higher.

The US government will sell $21b in 10-year notes tomorrow, $13b in 30-year bonds on Thursday and $32b 3’s this morning. Fed Vice-Chairwoman Yellen said yesterday that ‘commodity price rises do not warrant a policy shift’. A green light to own some US product through June.

In the O/N sessions, treasuries in the short end have found support after a nuclear warning and earthquakes in Japan sent global bourses lower, boosting demand for the relative safety of bonds.

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Shut It Down!

« Portugal Submits! | Home

By Mike Conlon | April 8, 2011

Yes that’s right, I’m talking about the government. We are less than 24-hours away from a federal government shutdown and it is an embarrassment that it has come to this as grown men and women cannot come to an agreement. There is much blame to go around and I say just throw ‘me all out and start afresh.

Nevertheless, the markets couldn’t care less as stocks and commodities are still pushing higher as nobody wants to get in the way of Bernanke’s money pump. With oil at $111 and gold making new, nominal all-time highs, the only place in the world where there isn’t inflation is at the US Fed.

Meanwhile, Japan has shaken off another earthquake that occurred overnight and it is business as usual as the Nikkei has pushed higher.

In the Euro zone, Portuguese politician may have made a big mistake when they rejected their own austerity measures in favor of the ones that are going to be imposed by Germany in order to receive the bailout funds. I guess it is politically more expedient to be able to blame someone else for the austerity coming down than to accept responsibility.

PPI data in the UK came in higher than expected though this is not necessarily “unexpected”, s everyone knows that the BOE has turned a blind eye to inflation. At least they have the guts to say yes there is inflation but we are choosing to ignore it; rather than Brake and the Fed’s complete denial that it exists at all.

In Canada, the number of jobs gained by the economy came in worse than expected, though the unemployment rate remained steady at 7.7%.

In the forex market:

Aussie (AUD): The Aussie is rocking higher now firmly trading above 1.05 vs. USD which, as you may have guessed, put in another all-time high.

Kiwi (NZD): The Kiwi is also trading higher as the only risk in the marketplace appears to be missing the boat on the inflation trade.

Loonie (CAD): The Loonie is also higher despite a weaker than expected jobs report as its high correlation to oil is the rising tide lifting this ship. (Click chart to enlarge)

Euro (EUR): The anti-Dollar properties of the Euro make it the most sought after currency this morning despite Portugal requesting a bailout and a new round of bank stress tests that are forthcoming. As long as German economic metrics keep coming better than expected (like exports this morning), then the Euro remains more attractive than the Dollar. (Click chart to enlarge)

Pound (GBP): As mentioned above, UK PPI input and output figures came in higher than expected showing that yes indeed inflation is very real and present in the UK. The choice to ignore it is another issue entirely.

Dollar (USD): Another “no confidence” vote taking place today in the US economy, with everyone selling Dollars and plowing money into just about anywhere else regardless of risk. Right now the riskiest asset appears to be the US dollar, and not being invested everywhere else appears to be opportunity cost risk as well.

Yen (JPY): The Yen has resumed its downtrend and is weakening despite another earthquake that happened last night. While the market was disappointed with the lack of BOJ stimulus in response to the natural disaster, the fundamentals of the Japanese economy may be weak enough to encourage Yen selling.

Where have all of the leaders gone in the world? The world has become one giant popularity contest and the person with the most twitter followers wins! Meanwhile, the tough decisions that need to be made fall by the wayside, and everyone continues on like it isn’t their fault.

Blame game politics, not just here in the US but abroad, have weakened the global economy and provided a false sense of security to those who need it the most. Meanwhile honest, hardworking people receive the brunt of the onus of trying to hold the generous global quagmire together, as they are forced to pay more for everything through the insidious tax known as inflation.

So I say just shut it down and purge the whole thing. It is sad that this is what it has come to and the games that politicians play affect real people’s lives. Only when we wake up and demand better, will things get better.

So keep selling that Dollar, to try to offset some of the inflation you are forced to bear today!

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Forex week in review: April 3-8

The Market got what it wanted this week when it came to Central Bank announcements. The RBA, BoJ, BoE and ECB all remain mindful of inflation. The ECB tightened rates +25bp, seemingly to begin  its rate normalization policy. Their actions will provide greater forex directionality in the medium term for investors. The beginning of policy divergence between the Fed and ECB is negative for the dollar and with risk appetite back with a vengeance it seems the market cannot get enough of the ‘carry’ trade. The looser monetary policy’s of the Fed and BoJ is allowing their currency to remain favorable funding vehicles.

EUROPE

• UK services PMI surprised with a sharp move higher to 57.1 from 52.6 in February (highest reading in 14-months). The composite PMI rose to 57.5 from 54.9, the strongest reading in over a year.
• Euro area services PMI showed a very solid gain last month, rising to 57.2 (revised up from 56.9), the highest level so far in the recovery. Core strength comes from Germany, Italy and France. In the periphery, Spain’s services PMI fell to 48.7 and Irish services PMI fell to 51.1. Euro-zone composite PMI remains at a very high level, despite the moderation in manufacturing, and consistent with solid growth.
• Moody’s cut Portugal’s sovereign rating to Baa1 from A3, with the negative outlook maintained.
• Despite downgrades, Portugal successfully issued EUR 1.01bn in T-bills, slightly above the EUR 750mn to EUR 1bn range.
• UK industrial production fell sharply in February (-1.2% vs. +0.4%, m/m), with January revised lower (+0.3%, m/m). The drop was mainly due to erratic items, the weakness will bias 1st Q GDP lower.
• In contrast, German factory orders rose sharply in February (+2.4% vs. +0.5%, m/m) and with an upward revision to January (+3.1%).
• Swiss inflation rose to +1.0%, y/y last month, pushed higher by energy and clothing components. Headline inflation is still benign compared to the SNB’s medium-term target of +2.0%, y/y.
• It was not a surprise, pushed by higher funding costs, Portugal’s Prime Minister announced a request for financial assistance from the Euro-zone and became the third member to do so after Greece and Ireland.
• Spain successfully sold €4.2bn of 3-year bonds. Perception is trying to decouple the Spanish markets from Portuguese stress to provided investors with greater comfort that peripheral financing stress is no longer a systemic threat or impediment to EUR appreciation.
• German industrial production came in very strong (+1.6% vs. +0.5% in February), with growth in January revised up to +2.0% from +1.8%.
• Not a surprise, the BoE left policy unchanged (+0.5%), as universally expected. Markets will have to wait for the release of the minutes on 20 April to gain insight on any possible changes in alignment within the divided MPC.
• As expected ECB hiked the repo rate +0.25bp to +1.25%, which gives some directionality to the FX space. Trichet tone was marginally hawkish, his statement that the ECB would ‘very closely monitor’ risks to inflation suggests that the next rate rise could come as early as June. This is a significant step towards normalizing policy conditions in the Euro-area.
• UK construction output (56.4 vs. 54.7) eases concerns about 1st Q GDP
• UK PPI release showed inflationary pressures remained high in March. Output PPI rose to + 5.4% and core-PPI moderated only slightly to +3.0%. Market continues to prices in an 80% chance of a +25bp hike by the July meeting.

Americas

• BoC’s Canadian business outlook survey sees slow growth on a higher loonie and commodity prices. Inflation expectations have ticked higher and respondents now expect inflation to trend at the upper end of the BoC inflation control target.
• US data showed that the service sector is expanding at a ‘moderate’ clip. ISM non-manufacturing index eased to 57.3, but still remains above its long-run average of 53.8. Respondents are concerned of a possible spillover effects from Japan, specifically with the supply chain.
• There were no surprises from the FOMC minutes. The meeting highlighted the dichotomy amongst the members on timing of exit. This certainly evident from the independent rhetoric jousting of late by various Fed speakers. The minutes reiterated that the FED would be hands off with QE2.
• US jobless claims extending their ‘modest’ downward trend, beating consensus estimates by-10k (+382k vs. +392k). Since peaking two-years ago, down over +40% from the high, claims continue to hover within a tight range below that psychological +400k print which points to a ‘gradual’ pace of hiring activity.
• Canada employment figures showed a disappointing flat headline reading (-1.5k). The details were more encouraging, with full time employment rising by 91k, and part time declining by an equivalent degree. Unemployment rate falls to +7.7%
• US inventories increased +1% in February, driven by a big gain in petroleum amid rising oil prices

ASIA

• In Australia, job ads were up another +1.3%, m/m in March
• The RBA left policy rates on hold at +4.75% with the statement nearly identical to last month’s. There was an additional sentence on Japan and oil prices, and a slight change in language around the labor market commentary from ‘firm in 2010’ to ‘growth moderated’. The level of yields is still the highest in the G10.
• PBoC hiked policy rates +25bp. Analysts expect China to keep policy rates and banks’ RRR unchanged for the next two months as evidence is mounting that policy tightening is biting into lending and consumption.
• Australia employment rose +37.8k in March and the February fall in employment was revised from -10k to only -8.6k. The unemployment rate eased from +5.0% to +4.9%. RBA considers this to be full employment.
• The Bank of Japan left key policy rates and its asset purchase program unchanged, disappointing those looking for new support measures. Policy makers revised down their economic assessment, and this to the provision of reserves in the banking system allows the Yen to be an attractive funding currency in this pro-carry environment.

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Report Portends Changes to Forex Reserve Currencies

This week’s Bank of International Settlements (BIS) quarterly report came with some interesting revelations (most of which I’ll discuss in a later post). Below, I’d like to focus on one particularly interesting section entitled, “Foreign exchange trading in emerging currencies.” This section carries tremendous implications for the future of reserve currencies and is a must read for fundamental analysts.

According to the BIS, “Foreign exchange turnover evolves in a predictable fashion with increasing income. As income per capita rises, currency trading cuts loose from underlying current account transactions…moreover, currencies with either high or very low yields attract more trading, consistent with their role as target and funding currencies in carry trades.” In other words, the most liquid currencies (and hence, most suitable reserve currencies) are primarily those of advanced economies and secondarily those with abnormal interest rates.

In theory, one would expect a close correlation between forex turnover and trade. In fact, this turns out to be precisely the case for lesser-developed countries. Since the capital markets of such countries are commensurately undeveloped, offering limited opportunities for foreign investment, most of the demand for their currencies stems directly from trade. In fact, the currencies of Malaysia, Indonesia, Saudi Arabia, and (notably) China closely fit this profile, with a 1:1 ratio between forex turnover and trade.

At the same time, the BIS discovered a strong correlation between the ratio of foreign exchange turnover to trade and GDP per capita.  That means that as a country grows economically and enters the realm of industrialized countries, its currency will experience exponential growth in turnover. For example, the British Pound and Japanese Yen are exchanged at a quantity that is 50 times greater than required for trading purposes. The ratio of forex turnover to trade for the US Dollar, meanwhile, exceeds 100!

The BIS was able to fit a regression line to the data that seemed to explain this phenomenon quite well. The majority of economies/currencies that it surveyed fall pretty close to this line, suggesting that forex turnover is exactly where it should be relative to GDP per capita and trade. In fact, the line runs directly through the Euro, Hong Kong Dollar, Canadian Dollar, and Swedish Krona, and Norwegian Krona.

There are also plenty of outliers. Given the size of China’s economy, for instance, the model would predict that turnover in the Chinese  Yuan should be 2-3 times what it currently is. Unsurprisingly, all of the world’s major reserve currencies (except for the Euro) can be found well on the other side of the regression line. Turnover in the US Dollar, Japanese Yen, and Australian Dollar is almost twice as high as the model predicts. Perhaps the most flagrant outlier is the New Zealand Dollar, which seems to be traded at a frequency that is 8-10x higher than it should be. Of course, New Zealand is a unique case; there isn’t another economy that is as small and stable, and yet always has higher-than-average interest rates.

One interpretation of this analysis is that demand for the all of the currencies that fall above the regression line should decline over time, and should experience at least some depreciation. The opposite can be said for currencies that currently fall the regression line, especially if their economies continue to expand at a faster-than average pace.

At the same time, it puts things into perspective. Even if demand for the Chinese Yuan doubled in accordance with the BIS model (which would necessitate looser capital controls, among other things), GDP per capital would need to increase 20x and US GDP per capita would need to remain constant in order for the Yuan to rival the Dollar in importance. Also, I’m beginning to wonder if the New Zealand Dollar isn’t in fact oversubscribed and overvalued…

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ECB Lifts Rates; BofE Holds Line

The European Central Bank today raised the benchmark lending rate by a quarter point to 1.25 percent. Describing the ECB’s monetary policy as “accommodative”, ECB President Jean-Claude Trichet said that inflation risk remained on the upside and that an increase in the rate was necessary.

Trichet also hinted that additional interest rate hikes before the end of the year could not be ruled out.

“It is essential that recent price developments do not give rise to broad-based inflationary pressures over the medium term,” Trichet noted.

Also today, the Bank of England’s Monetary Policy Committee voted to keep the Bank Rate at 0.5 percent. The Bank Rate is the interest paid on commercial bank reserves held by the Bank of England.

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G20 Pressures China, Despite Yuan Appreciation

Since the People’s Bank of China (PBOC) unfixed the Chinese Yuan in June, it has appreciated 4.5%. Moreover, for a handful of reasons, it looks like China will continue allowing the RMB to appreciate at the same steady pace for the foreseeable future. And yet, the international community continue to use China as a scapegoat for all global economic ills, and are pressuring it to stop trying to control the Yuan altogether.

At the recent G20 conference in China, US Treasury Secretary Tim Geithner circumvented China’s request to avoid discussing its currency policy: “Flexible exchange rates help countries better absorb shocks and that the tension between flexible currencies and those that are ‘tightly managed’ is ‘the most important problem to solve in the international monetary system today.’ ” Naturally, Chinese officials countered that the Dollar is to blame for the recent financial crisis and the ongoing economic imbalances.

If China was the only country to attempt to control its currency, perhaps the rest of the world would be willing to overlook it and write it off to ideological differences like they do with many of its protectionist economic policies. In this case, however, China’s tight control of the Yuan has spurred many of the countries with which it competes to similarly intervene in forex markets. In the last week alone, South Korea, Malaysia, Singapore, and Thailand are all suspected of buying Dollars to hold down their respective currencies. Meanwhile, Brazil is enhancing its capital controls and Japan stands ready to intervene should the Yen spike again.

To quote Secretary Geithner again, “This asymmetry [between nations that intervene and those that don't] in exchange rate policies creates a lot of tension. It magnifies upward pressure on those emerging-market exchange rates that are allowed to move and where capital accounts are much more open. It intensifies inflation risk in those emerging economies with undervalued exchange rates. And, finally, it generates protectionist pressures.” In short, when one country decides not to play the rules, other countries are quick to catch on. [To be fair, while the US doesn't intervene directly on behalf of the Dollar, it still deserves some blame for this tension because of QE2 and the like].

If any country appears to be taking these lessons to heart, however, it is China. To combat inflation, it has raised interest rates several times over the last twelve months, including yesterday’s surprise 25 basis point hike. Given that official inflation remains above 5% (and living here, I can tell you that the actual rate is probably 10-20%), the PBOC has no choice but to continue tightening monetary policy if it wishes to avoid social unrest. To counter the inevitable upward pressure on the Yuan, it has taken such measures as prodding Chinese firms to look abroad for acquisition targets. China’s forex policy is designed to serve one very important end: to buttress the competitiveness of its export sector. However, there are early indications that China’s preeminent position as the world’s sweatshop may be about to slide. Anecdotal reports show that manufacturers are unnerved by wage and raw materials inflation, and are uprooting factories. In the short-term, some of this production will move inland from the coast, but even this has its limits. According to Credit Suisse, “Salaries for China’s estimated 150 million migrant workers will rise 20 to 30 percent a year for the next three to five years…’It may take a decade for China to see its export competitiveness erode, but we have seen the beginning of this happening.’ ”

With this in mind, it’s clearly futile for China to continue to focus its economic policy around low-cost, labor-intensive exports. Likewise, it’s ridiculous to continue to artificially depress the Yuan, especially if it’s serious about turning it into a global reserve currency. I think Chinese policymakers recognize this, and I stand by my earlier prediction that the Yuan will maintain a steady pace of appreciation for the foreseeable future.

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