FX Perspectives Aug 08 – Pre CB Rate Announcements
Considerations
I do not hold a holy grail, a crystal ball or rub a rabbit’s foot. If that is what you are looking for, you won’t find it on the computer where I’m seated. If you want a holy grail, the best I can offer you is this… max risk on total exposure should not exceed 1.5% of base (notional) non-diversified equity. Even that’s a little high. If you are a “holy grail seeker” it will cost you more than you will earn and I’m sorry I can’t help you.
To succeed in this market requires a few essential qualities:
1. A thorough understanding of this market and what drives price
2. You must develop and maintain the integrity of your psychological profile
3. You must become an “Independent Thinker”
4. Be absolutely clear in your trading plan and know exactly what defines your decisions and why, from the beginning to the end of a position
5. Firm and disciplined equity management protocol tailored to your method
6. Don’t think you know what’s going to happen next
7. Think in terms of probabilities, not affirmatives
My Trading Approach
I trade FX cash/spot, outright forwards, DCI’s and some options, when necessary. It is important to be cognizant of the micro and macroeconomic environment and what is driving price, whether it makes sense or not. We engage in short, medium and long term trades combining both technical and fundamental aspects. Shorter term are more technical and less fundamental while longer term are more fundamental and less technically driven decisions. I trade technical patterns that consider volatility, range, time of day, fractals and Fibonacci. Fundamentally, my decisions are based on perspectives driven by Interest Rate Spreads/Differentials and Economic Growth. I specialize in AUD/JPY, but also have a predilection for GBP/USD and consider other G10 pairs depending on where opportunities are presenting themselves per rate spreads and economic growth/weakness. My approach can be difficult to adapt, but once done so, it is surprisingly straight forward and simple. I know exactly what I am looking for in market dynamics. The approach suits a certain temperament and is not for everyone.
Current Perspective – Released Aug 4, 2008
Big week - with announcements out of RBA, MPC, FOMC and ECB press conference
EUR/USD
I’ve been amused to observe (as traders we are objective observers assessing probabilities rather than formulating firm opinions and beliefs, that may alter the decision making process) the emotional and market response to the FED’s hawkish jawboning of the USD, as it relates to interest rates, combined with the spirit of Treasury Secretary Paulson’s “strong dollar policy,” which raises the question of what kind of smoke has filled the room. Interest rate hikes and strong dollar policy are certainly what they would like the financial markets to believe. While the FED is caught between high inflation (food and energy) and slow economic growth, they have no reason to be smoking cigars, rather are struggling to find a way out. I pose the question for three reasons; 1. The smoke has altered their cognitive ability to clearly see the strength of the economic slowdown, while hoping inflationary contingencies, i.e. food and energy, ease off to open the door for rate hikes along with the odd creative stimulus package tax payers are paying for. 2. They have deceived themselves into thinking the financial markets will actually believe them, which they had for the short term, to drive USD strength and ease market concerns. 3. The smoke is so thick they scrambled for a short term injection to buy time into the future, which actually worked, to some degree.
Interestingly, since such a scenario (3) presented itself in June/July we saw two fundamental shifts; 1. The market quickly became wise to the FED’s deception and began to sell USD, again, followed closely by # 2. Five days after EUR/USD achieved a peak of 1.6037, further evidence of Eurozone economic slowdown became more evident as a series of German data showed more concrete signs of weakness, notably the German ZEW coming in at -63.9 vs. -56.0 expected compared to -52.7 in June. German ZEW and IFO sentiment surveys are important to note when global weakness sets in, as Germany represents the largest economy in the Eurozone and therefore, materially impacts EUR movement and sentiment. This and other data were offset by CPI flash estimate y/y at 4.1%, distorting rate expectations to the upside.
Aforementioned considered, we could go into great detail on each component of data and its impact on current economic shifts and price movement, but you can get that information anywhere. To summarize, the market has largely priced USD negative data and a percentage of expectation of rate adjustments into Q1 09. Recent USD strength has resulted from a string of weakness out of Eurozone, namely Germany, which has been the last to stand in the region. Trichet’s last statement was a “wait and see” approach on rate expectations. With the recent sequence of negative data out of Germany the market is now pricing in the potential for rate cuts for Q1 09, which will become clearer this week following ECB Press Conference on Thursday. Meanwhile, the FED got the market excited about rate hikes before year end, of which there is an extremely remote possibility of that happening, in my view, with some pre-emptive jawboning. The FED offered words of deception rather than facts based on firm data and reality.
Concerning oil and the USD, sure there is a relationship between the price movement of oil and the USD as the market views strong oil as inflationary and USD negative. This is a transient connection that is expressing itself in the current market environment and is merely psychological and rationalized rather than an effective tool that can assist you in discerning market direction, taking on, and managing trades related to USD or other ccy’s.
I am looking for the following potential scenario; August has thinner liquidity, therefore more volatile price action. As we are in uncertain times in the financial markets, we could see some unusual moves, particularly around Aug 14th on fund redemption deadlines (*JPY). Oil and USD relationship will dissolve as oil strength holds into year end, while USD strength holds primarily as a beneficiary of weakening data streams from other ccy’s including high yielders re commodity weakness. Since USD weakness has been largely priced in, it may gain modestly from the lagging economic weakness of other regions as rate spreads (2yr, 10yr Yield measured against equivalent) move in favor of USD as currently seen against GBP.
Despite hawkish elements contained within the report, released on the back of the Eurozone CPI release which came in higher at 4.1%, the market chose to focus on downside risks for the Eurozone, and it is becoming increasingly clear that the ECB is now more attentive to downside risks. This week's interest rate decision will be crucial for ECB rate expectations and I believe it will be very difficult for Trichet to continue his "no bias" position. Data has been very weak over the past month and the decline in oil prices has contributed to some easing in inflation expectations. The ECB may feel that a further hike will be necessary to decisively contain price pressures but this may come at a great cost to the economy and even undermine the ECB, therefore, I see no hint of a hike.
FED, look for possible rate cuts as real estate continues to fall, and costs rise, driving down growth under the weight of inflation and the dilemma for FED persists.
I anticipate that the dollar will continue to head higher if rate spreads continue to move in the USD favor, while slowing global growth will also negatively affect asset allocation flows away from the US and also encourage repatriation and risk aversion. A break of 1.5300 will see fear and settlement of the longs from 1.4800, which will offer the next major support. However, clear signals of rate cuts from central banks, especially the ECB, will be needed before the dollar achieves a material upside move. Where I struggle, and why I’m relatively neutral, with EUR/USD, is the heightened possibility of rate FED rate cuts into the year end, which could turn the course on rate spreads and soften the dollars potential to decline.
Risk: Central Bank Speak to disrupt financial market viewpoints on rate expectations. Rescue plans, fund redemptions (USD and JPY positive). EUR/USD – Range-bound, with possible base at 1.5200 or higher, and choppy as economic data and rate spreads come into balance while the market waits for the real story out of the FED. The re-pricing of rate expectations to the downside will be offset by EUR rate expectations, hence the view as range-bound.
Rate Decision ECB: No Change at 4.25%. The details in the statement will be key and a trend could take root. ECB members are likely to downgrade Eurozone economic outlook evident in recent deterioration in the data. Risks for a downturn have intensified and it will likely be reflected in the statement, but in balance with inflation risks. ECB will be under political pressure to remain on hold. If ECB maintains hawkish bias, buy EUR/GBP, looking for .8000 and .8100 and possible breakout as rate spreads move against GBP into Q1.
Rate Decision FED: Hold at 2.0% with a few optimists’ calling for increase. Smoking something? Fed funds futures pricing in only 8% chance of hike. Dovish on growth, hawkish on inflation, so no material impact. As mentioned above, FED is strangled by weak economic activity from credit crunch and high inflation killing consumer and growth. Press statement will probably not be much different from June 25 tone, therefore USD will not get much boost at the time of statement. FED may cut rates by year end.
GBP
Why the Pound is more likely to fall into 09’
As I’d mentioned above, my trade considerations and perspectives are derived from economic growth and interest rates/spreads/differentials. It is clear that spreads have contributed to the current weakness of the USD today. We saw evidence of this shift in 05’ when rates were rising and USD rallying. I’ve been calling GBP/USD short to my members since 2.0800 in late Nov 07, for those who’ve had the patience. We are seeing a lagging response to UK housing deterioration in relation to the US as a result of the interest rate outlook for the UK, which has supported GBP vs. USD with bank rates currently at 5.00% vs. 2.00% respectively. This is likely to shift slowly (nararow) over the coming months.
Let’s look at UK housing where UK consumers and institutions have excessive exposure yet to unravel:
· Debt to disposable income for UK consumer is approximately 15% higher
· Residential mortgage debt in the UK is 14% higher than the US and mortgage debt per capita 30% higher
· Total RMBS exposure as a percentage of GDP is approximately 6.5% more than the US counterpart, although much smaller in terms of total capital
· Since the mid 1990’s housing prices in the UK have tripled, while in the US prices have doubled, on average
· It is possible we may see more Northern Rock like rescues with other mortgage lenders in the year to come
· Just last week all data pointed down – Mortgage Approvals down 36K vs. 37K expected. Net Lending to Individuals m/m 4.0B vs. 5.0B expected. CBI Distributive Trades Realized -36 vs. -15 expected and -9 previous. GfK Consumer Confidence -39 vs. -37 exp. and -34 previous. Nationwide HPI m/m -1.7 vs. -1.2 exp and -0.8 previous. Manufacturing PMI 44.3 vs. 45.5 exp.
The data from last week alone further supports economic slowdown in peripheral aspects of the UK economy, which points to a dovish view on rates and speculation for rate cuts. Last week saw a 30bp change of 2yr rate spreads between UK and US, meaning the markets are pricing in the potential for rate cuts in the UK, in simple terms.
In summary, as there is a 3.00% differential between US and UK Central Bank Rates, the Pound is more vulnerable to deeper rate cuts and RMBS exposure. This hits our two primary factors affecting exchange rates; interest rates and economic growth, both of which are likely to be negatively affected vs. USD. A potentially good currency play is to sell GBP/USD (on rallies – DON’T CHASE!) over a 6-12 month timeframe.
BoE Rate Decision: Consensus that Bank will leave rates on hold at 5.0%. There is no statement released if there is no change, therefore, the market will have to look for other clues re monetary policy shifts. Economic weakness will become a reality, so sell GBP on rallies. 50bp cut by year end and another 25bp in Q1 09’
AUD
Mentioned above, I trade AUD/JPY and last year we moved client funds largely into AUD’s in a range of instruments and FX plays. We have done well on the trades and have recently settled almost all of our positions. I also have a “long only” AUDJPY trading method, which is also flat, at present, as I anticipate reasonable AUD declines along with a risk avoidance JPY rally to set up our next series of positioning on the pair. You need only two good position trades a year to do well and they will likely outperform all your smaller trades throughout the year, depending on your approach.
The Reserve Bank of Australia will report their interest rate decision on Tuesday this week. There is a firm consensus that the RBA will leave rates unchanged at 7.25%. Certainly, I agree with the consensus forecast, but would also note that there has been a rapid deterioration in the Australian economy reflected in recent data and the bank's next move looks likely to be a cut. We have seen the market price in the weakening economy and anticipation of rate cuts into the future with heavy AUD selling. Employment figures have been improving, however, unemployment falling to 4.2%, while consumer confidence and retail sales deteriorated since the last RBA meeting. Business confidence and lending activity fell off in the last month, also. The worsening economic situation is being offset by higher inflation as in other major global regions. CPI registered an annual increase of 4.5%, which is a cycle high. Similar to the dilemma in other regions, the bank is reluctant to cut rates under such excessive inflationary environment. The event risk this week is that the RBA cuts rates at this meeting, which is ill expected. Depending on how deeply the market has priced in negative AUD sentiment, this would further stimulate AUD selling. Offsetting AUD negatives is the prospect of significant foreign direct investment in Australia’s resource sector, particularly by China, which will support AUD.
I anticipate a squeeze on over exposed AUD/JPY and NZD/JPY margin traders in the weeks to come. I welcome a pullback on the pairs to set up new positioning, yet to be determined. The underlying fact remains, the interest rate differential between JPY and NZD and AUD remains attractive, but we must wait for price stability as it relates to rate expectations to discern our next move to take advantage of value and interest rate differentials.
RBA Rate Decision: Consensus - Hold. The verbiage will offer clues. For what it’s worth, OIS markets are pricing in a 5bp rate cut at tomorrow’s meeting and a cumulative 39.5bp by year end. Meaning the market expects RBA to definitely cut rates by 25bp and a 60% probability of a second cut by year end. Look for AUD/USD to retrace some of recent losses on any neutral “wait and see” comments from RBA or rally on a “less dovish” statement, in which case, buy.
Recommendation: wait until margin traders get washed.
JPY
The JPY has been under selling pressure from risk appetite and gains in carry positions, but I’m doubtful this is sustainable through the summer, especially as the market prices in rate cuts in the high yielders and the weight of global economic slowdown persists. I anticipate modest JPY strength in the coming months.
Gold
Well supported. Look for a new version of Bretton Woods in the (distant) future as Gold hits CB’s pain points.
Risk: Central Bank intervention to persist as witnessed on 4/24/08
Rate Decisions and the Week Ahead
Tip: With a string of rate announcements this week, we anticipate the CB’s to remain on hold. The CB’s will use carefully selected verbiage and wordsmith the announcement to manage expectations and elicit a particular market response. Get in the habit of listening for such clues at any CB speak event or rate announcement, this will drive currency trends, as it reflects CB’s view on economic growth stimulating market participants response to rate expectations. CB verbiage and surprise rate decisions can significantly alter market sentiment and the views issued in this report.
Homework: Read the summary of the Central Bank statements and observe what impact it had on price movement and shift in sentiment. This will give you a feel for potential changes in monetary policy and the market pricing in such forecasting.
Good Luck with your trading and be careful out there!
Considerations
I do not hold a holy grail, a crystal ball or rub a rabbit’s foot. If that is what you are looking for, you won’t find it on the computer where I’m seated. If you want a holy grail, the best I can offer you is this… max risk on total exposure should not exceed 1.5% of base (notional) non-diversified equity. Even that’s a little high. If you are a “holy grail seeker” it will cost you more than you will earn and I’m sorry I can’t help you.
To succeed in this market requires a few essential qualities:
1. A thorough understanding of this market and what drives price
2. You must develop and maintain the integrity of your psychological profile
3. You must become an “Independent Thinker”
4. Be absolutely clear in your trading plan and know exactly what defines your decisions and why, from the beginning to the end of a position
5. Firm and disciplined equity management protocol tailored to your method
6. Don’t think you know what’s going to happen next
7. Think in terms of probabilities, not affirmatives
My Trading Approach
I trade FX cash/spot, outright forwards, DCI’s and some options, when necessary. It is important to be cognizant of the micro and macroeconomic environment and what is driving price, whether it makes sense or not. We engage in short, medium and long term trades combining both technical and fundamental aspects. Shorter term are more technical and less fundamental while longer term are more fundamental and less technically driven decisions. I trade technical patterns that consider volatility, range, time of day, fractals and Fibonacci. Fundamentally, my decisions are based on perspectives driven by Interest Rate Spreads/Differentials and Economic Growth. I specialize in AUD/JPY, but also have a predilection for GBP/USD and consider other G10 pairs depending on where opportunities are presenting themselves per rate spreads and economic growth/weakness. My approach can be difficult to adapt, but once done so, it is surprisingly straight forward and simple. I know exactly what I am looking for in market dynamics. The approach suits a certain temperament and is not for everyone.
Current Perspective – Released Aug 4, 2008
Big week - with announcements out of RBA, MPC, FOMC and ECB press conference
EUR/USD
I’ve been amused to observe (as traders we are objective observers assessing probabilities rather than formulating firm opinions and beliefs, that may alter the decision making process) the emotional and market response to the FED’s hawkish jawboning of the USD, as it relates to interest rates, combined with the spirit of Treasury Secretary Paulson’s “strong dollar policy,” which raises the question of what kind of smoke has filled the room. Interest rate hikes and strong dollar policy are certainly what they would like the financial markets to believe. While the FED is caught between high inflation (food and energy) and slow economic growth, they have no reason to be smoking cigars, rather are struggling to find a way out. I pose the question for three reasons; 1. The smoke has altered their cognitive ability to clearly see the strength of the economic slowdown, while hoping inflationary contingencies, i.e. food and energy, ease off to open the door for rate hikes along with the odd creative stimulus package tax payers are paying for. 2. They have deceived themselves into thinking the financial markets will actually believe them, which they had for the short term, to drive USD strength and ease market concerns. 3. The smoke is so thick they scrambled for a short term injection to buy time into the future, which actually worked, to some degree.
Interestingly, since such a scenario (3) presented itself in June/July we saw two fundamental shifts; 1. The market quickly became wise to the FED’s deception and began to sell USD, again, followed closely by # 2. Five days after EUR/USD achieved a peak of 1.6037, further evidence of Eurozone economic slowdown became more evident as a series of German data showed more concrete signs of weakness, notably the German ZEW coming in at -63.9 vs. -56.0 expected compared to -52.7 in June. German ZEW and IFO sentiment surveys are important to note when global weakness sets in, as Germany represents the largest economy in the Eurozone and therefore, materially impacts EUR movement and sentiment. This and other data were offset by CPI flash estimate y/y at 4.1%, distorting rate expectations to the upside.
Aforementioned considered, we could go into great detail on each component of data and its impact on current economic shifts and price movement, but you can get that information anywhere. To summarize, the market has largely priced USD negative data and a percentage of expectation of rate adjustments into Q1 09. Recent USD strength has resulted from a string of weakness out of Eurozone, namely Germany, which has been the last to stand in the region. Trichet’s last statement was a “wait and see” approach on rate expectations. With the recent sequence of negative data out of Germany the market is now pricing in the potential for rate cuts for Q1 09, which will become clearer this week following ECB Press Conference on Thursday. Meanwhile, the FED got the market excited about rate hikes before year end, of which there is an extremely remote possibility of that happening, in my view, with some pre-emptive jawboning. The FED offered words of deception rather than facts based on firm data and reality.
Concerning oil and the USD, sure there is a relationship between the price movement of oil and the USD as the market views strong oil as inflationary and USD negative. This is a transient connection that is expressing itself in the current market environment and is merely psychological and rationalized rather than an effective tool that can assist you in discerning market direction, taking on, and managing trades related to USD or other ccy’s.
I am looking for the following potential scenario; August has thinner liquidity, therefore more volatile price action. As we are in uncertain times in the financial markets, we could see some unusual moves, particularly around Aug 14th on fund redemption deadlines (*JPY). Oil and USD relationship will dissolve as oil strength holds into year end, while USD strength holds primarily as a beneficiary of weakening data streams from other ccy’s including high yielders re commodity weakness. Since USD weakness has been largely priced in, it may gain modestly from the lagging economic weakness of other regions as rate spreads (2yr, 10yr Yield measured against equivalent) move in favor of USD as currently seen against GBP.
Despite hawkish elements contained within the report, released on the back of the Eurozone CPI release which came in higher at 4.1%, the market chose to focus on downside risks for the Eurozone, and it is becoming increasingly clear that the ECB is now more attentive to downside risks. This week's interest rate decision will be crucial for ECB rate expectations and I believe it will be very difficult for Trichet to continue his "no bias" position. Data has been very weak over the past month and the decline in oil prices has contributed to some easing in inflation expectations. The ECB may feel that a further hike will be necessary to decisively contain price pressures but this may come at a great cost to the economy and even undermine the ECB, therefore, I see no hint of a hike.
FED, look for possible rate cuts as real estate continues to fall, and costs rise, driving down growth under the weight of inflation and the dilemma for FED persists.
I anticipate that the dollar will continue to head higher if rate spreads continue to move in the USD favor, while slowing global growth will also negatively affect asset allocation flows away from the US and also encourage repatriation and risk aversion. A break of 1.5300 will see fear and settlement of the longs from 1.4800, which will offer the next major support. However, clear signals of rate cuts from central banks, especially the ECB, will be needed before the dollar achieves a material upside move. Where I struggle, and why I’m relatively neutral, with EUR/USD, is the heightened possibility of rate FED rate cuts into the year end, which could turn the course on rate spreads and soften the dollars potential to decline.
Risk: Central Bank Speak to disrupt financial market viewpoints on rate expectations. Rescue plans, fund redemptions (USD and JPY positive). EUR/USD – Range-bound, with possible base at 1.5200 or higher, and choppy as economic data and rate spreads come into balance while the market waits for the real story out of the FED. The re-pricing of rate expectations to the downside will be offset by EUR rate expectations, hence the view as range-bound.
Rate Decision ECB: No Change at 4.25%. The details in the statement will be key and a trend could take root. ECB members are likely to downgrade Eurozone economic outlook evident in recent deterioration in the data. Risks for a downturn have intensified and it will likely be reflected in the statement, but in balance with inflation risks. ECB will be under political pressure to remain on hold. If ECB maintains hawkish bias, buy EUR/GBP, looking for .8000 and .8100 and possible breakout as rate spreads move against GBP into Q1.
Rate Decision FED: Hold at 2.0% with a few optimists’ calling for increase. Smoking something? Fed funds futures pricing in only 8% chance of hike. Dovish on growth, hawkish on inflation, so no material impact. As mentioned above, FED is strangled by weak economic activity from credit crunch and high inflation killing consumer and growth. Press statement will probably not be much different from June 25 tone, therefore USD will not get much boost at the time of statement. FED may cut rates by year end.
GBP
Why the Pound is more likely to fall into 09’
As I’d mentioned above, my trade considerations and perspectives are derived from economic growth and interest rates/spreads/differentials. It is clear that spreads have contributed to the current weakness of the USD today. We saw evidence of this shift in 05’ when rates were rising and USD rallying. I’ve been calling GBP/USD short to my members since 2.0800 in late Nov 07, for those who’ve had the patience. We are seeing a lagging response to UK housing deterioration in relation to the US as a result of the interest rate outlook for the UK, which has supported GBP vs. USD with bank rates currently at 5.00% vs. 2.00% respectively. This is likely to shift slowly (nararow) over the coming months.
Let’s look at UK housing where UK consumers and institutions have excessive exposure yet to unravel:
· Debt to disposable income for UK consumer is approximately 15% higher
· Residential mortgage debt in the UK is 14% higher than the US and mortgage debt per capita 30% higher
· Total RMBS exposure as a percentage of GDP is approximately 6.5% more than the US counterpart, although much smaller in terms of total capital
· Since the mid 1990’s housing prices in the UK have tripled, while in the US prices have doubled, on average
· It is possible we may see more Northern Rock like rescues with other mortgage lenders in the year to come
· Just last week all data pointed down – Mortgage Approvals down 36K vs. 37K expected. Net Lending to Individuals m/m 4.0B vs. 5.0B expected. CBI Distributive Trades Realized -36 vs. -15 expected and -9 previous. GfK Consumer Confidence -39 vs. -37 exp. and -34 previous. Nationwide HPI m/m -1.7 vs. -1.2 exp and -0.8 previous. Manufacturing PMI 44.3 vs. 45.5 exp.
The data from last week alone further supports economic slowdown in peripheral aspects of the UK economy, which points to a dovish view on rates and speculation for rate cuts. Last week saw a 30bp change of 2yr rate spreads between UK and US, meaning the markets are pricing in the potential for rate cuts in the UK, in simple terms.
In summary, as there is a 3.00% differential between US and UK Central Bank Rates, the Pound is more vulnerable to deeper rate cuts and RMBS exposure. This hits our two primary factors affecting exchange rates; interest rates and economic growth, both of which are likely to be negatively affected vs. USD. A potentially good currency play is to sell GBP/USD (on rallies – DON’T CHASE!) over a 6-12 month timeframe.
BoE Rate Decision: Consensus that Bank will leave rates on hold at 5.0%. There is no statement released if there is no change, therefore, the market will have to look for other clues re monetary policy shifts. Economic weakness will become a reality, so sell GBP on rallies. 50bp cut by year end and another 25bp in Q1 09’
AUD
Mentioned above, I trade AUD/JPY and last year we moved client funds largely into AUD’s in a range of instruments and FX plays. We have done well on the trades and have recently settled almost all of our positions. I also have a “long only” AUDJPY trading method, which is also flat, at present, as I anticipate reasonable AUD declines along with a risk avoidance JPY rally to set up our next series of positioning on the pair. You need only two good position trades a year to do well and they will likely outperform all your smaller trades throughout the year, depending on your approach.
The Reserve Bank of Australia will report their interest rate decision on Tuesday this week. There is a firm consensus that the RBA will leave rates unchanged at 7.25%. Certainly, I agree with the consensus forecast, but would also note that there has been a rapid deterioration in the Australian economy reflected in recent data and the bank's next move looks likely to be a cut. We have seen the market price in the weakening economy and anticipation of rate cuts into the future with heavy AUD selling. Employment figures have been improving, however, unemployment falling to 4.2%, while consumer confidence and retail sales deteriorated since the last RBA meeting. Business confidence and lending activity fell off in the last month, also. The worsening economic situation is being offset by higher inflation as in other major global regions. CPI registered an annual increase of 4.5%, which is a cycle high. Similar to the dilemma in other regions, the bank is reluctant to cut rates under such excessive inflationary environment. The event risk this week is that the RBA cuts rates at this meeting, which is ill expected. Depending on how deeply the market has priced in negative AUD sentiment, this would further stimulate AUD selling. Offsetting AUD negatives is the prospect of significant foreign direct investment in Australia’s resource sector, particularly by China, which will support AUD.
I anticipate a squeeze on over exposed AUD/JPY and NZD/JPY margin traders in the weeks to come. I welcome a pullback on the pairs to set up new positioning, yet to be determined. The underlying fact remains, the interest rate differential between JPY and NZD and AUD remains attractive, but we must wait for price stability as it relates to rate expectations to discern our next move to take advantage of value and interest rate differentials.
RBA Rate Decision: Consensus - Hold. The verbiage will offer clues. For what it’s worth, OIS markets are pricing in a 5bp rate cut at tomorrow’s meeting and a cumulative 39.5bp by year end. Meaning the market expects RBA to definitely cut rates by 25bp and a 60% probability of a second cut by year end. Look for AUD/USD to retrace some of recent losses on any neutral “wait and see” comments from RBA or rally on a “less dovish” statement, in which case, buy.
Recommendation: wait until margin traders get washed.
JPY
The JPY has been under selling pressure from risk appetite and gains in carry positions, but I’m doubtful this is sustainable through the summer, especially as the market prices in rate cuts in the high yielders and the weight of global economic slowdown persists. I anticipate modest JPY strength in the coming months.
Gold
Well supported. Look for a new version of Bretton Woods in the (distant) future as Gold hits CB’s pain points.
Risk: Central Bank intervention to persist as witnessed on 4/24/08
Rate Decisions and the Week Ahead
Tip: With a string of rate announcements this week, we anticipate the CB’s to remain on hold. The CB’s will use carefully selected verbiage and wordsmith the announcement to manage expectations and elicit a particular market response. Get in the habit of listening for such clues at any CB speak event or rate announcement, this will drive currency trends, as it reflects CB’s view on economic growth stimulating market participants response to rate expectations. CB verbiage and surprise rate decisions can significantly alter market sentiment and the views issued in this report.
Homework: Read the summary of the Central Bank statements and observe what impact it had on price movement and shift in sentiment. This will give you a feel for potential changes in monetary policy and the market pricing in such forecasting.
Good Luck with your trading and be careful out there!
You are what you do, trade with discipline. Chris Lori, CTA