FX News Trading For The Week Of May 20-And Beyond-Video Update

Bubbles, Bubbles Everywhere:

http://www.cnbc.com/id/15840232?video=326813795&play=1

Bubbles in Asset prices, Bubbles in Liquidity, Bubbles in Stock Markets, Carry Trades, Housing, Credit, M&A Activity-the list goes on and on. No one knows how far the bubbles can stretch or when they could burst.

World equity markets to a large degree are being driven higher by the vast amount of liquidity (i.e. cheap credit) driving the M&A bubble. Private equity buys a distressed asset like Chrysler because they think they can turn it around and sell it for a profit with borrowed money. Thomson buys Reuter's because they want to expand market share with borrowed money. Money is cheap and available and as long as it is-the deals will go on. It's creating a frenzy of trading activity because it's helping to drive the indicies up to record levels.

So how does this help you trade currency?

Look at Friday for guidance. The Chinese raised borrowing costs and markets got nervous. The carry trade currencies started free-falling until they calmed down. What's that tell you?

It's a fragile existence that's built on a house of cards-and it doesn't take much "wind" to blow those cards over.

As soon as some of the loans go bad, as soon you hear about liquidity drying up, as soon as Central Bankers and/or people like Henry Paulson start talking about anything that sounds like they think markets are extended to a dangerous point and that risk is being ignored-things could come down rapidly, or as fast as electronic markets will allow before the servers go "poof" (as happened in February).

Currency pairs like GBP/JPY, EUR/JPY will drop like bombs. A frenzy will ensue in the effort to exchange Pounds, Euros etc into Dollars and Dollars into Yen, because that's what happens when carry trades collectively and rapidly unwind.

There's no better time to trade then when the market is thinking collectively because that's when it acts collectively. That's the time to trade your larger positions, so here's my plan:

I'm gonna put a really nice chunk of change into my currency account, but not because I want to take a position right now. I just want to have both barrels loaded for when that turkey walks by. I don't know exactly when he's comin', but I know he is so I want to be ready. For now i'm gonna wait patiently and trade my normal positions, but when I see tom's fat head in my sites-he's gettin' both barrels.

This is the kind of thing i'm talking about:

International Monetary Fund Managing Director Rodrigo de Rato reiterated his warning about the risks to the international monetary system from extreme currency positions.

'It's still risky,' he said.

At February's G7 in Essen, Germany, Rato warned hedge funds in particular to consider the possibility of rapid changes in the value of currencies when building up carry trade positions. In carry trades investors borrow in low-yielding currencies like the yen to buy higher-yielding assets.

In recent weeks, the euro has surged to record highs against the yen, partly because of higher interest rates in the euro zone but also because of mounting carry trades, which have caused the yen to drop dramatically.

Additionally, China's move yesterday to raise interest rates by 50bp's was an effort to cool the over-heated economy and stock market. Whether this provokes a reaction when it's market opens Sunday remains to be seen, but it's something to be aware of.

The February loss of 9% in the Chinese stock market helped to cause a correction in world equity markets that sparked a 1600 pip sell-off in GBP/JPY.

Like you, I'm expecting a massive sell-off soon in the yen pairs because the extreme rate that the pairs are at now is somewhat unsustainable. China has already taken a move to increase its interest rates and to widen the trading band to 0.5%. However, the sell-off would not happen now. It might take some time and I'm loading my barrels as well to take advantage of it.

Absent some sort of major problem that either stems from the US-China trade talks and/or the apparent inevitability of tariffs-markets are not likely to have any type of reall sustained crash.

What the financial world today is enjoying today is the fruit of the financial globalization tree and likely, this tree will bear fruit for a very long time to come.

The free flow of capitol and risk in the open market combined with central bank policies that have collectively kept inflation under control has created an investment nirvana.

Money is cheap to borrow and more then readily available because it can be invested in the most conservative investment (US Treasury notes) at rates that are higher then inflation and without fear that the situation will change.

The carry system of funding is providing another source of easy profit that shows no signs of waning, because the efficiencies of global currency exchange have reduced volitility in these risky positions.

Risk can be packaged and sold like any other commodity in the credit derivitive market and when it is, it creates a net effect of less risk actually being in the market.

To put it simply-if money is in endless supply and it's value does not look to be eroded by inflation and if risk can be spread among a wide population of market participants-you have Nirvana.

The globalization of financial markets has created an Economic Nirvana on a world-wide scale that will only improve if the great economic minds of today can keep the politicians as far away from global economic policy as possible.

George Bush will be blamed for Iraq, but he should also be commended for the appointment of Henry Paulson to the Treasury and Ben Bernanke to the Fed.

They are two of the major proponents of what we all learned in eco 101-Adam Smith and Free trade, except now it's being really applied to internatioanl markets.

You can say that the G7 world, which right now controls about two thirds of the world's economy, exists in a utopia of international Adam Smith-like free trade, built upon four conerstones that are as solid as anything ever built.

1. Goods and services (including and especially financial services) flow freely and unfettered across international borders.

2. Cheap money is available in a near-limitless supply, the value of which will not erode thanks to the collective actions of the Central Banks in controlling inflation.

3. Risk that can easily be spread thru the international credit derivitive market while being profited from.

4. Currencies that float openly without intervention, so volitility is low.

What we have is a bubble that is the result of something that is real because it's built on an inflation-free world where free markets can act to their full potential. Bubble is really the wrong word for what we have now because of the word bubble's negative connotation.

This is no internet bubble; one in which profitless assets were over-valued in a speculative frenzy. This is no frenzy. This is a situation built on over 100 years of economic theory applied on an international scale.

There's only one thing thing that can hurt it: No-nothing political interference, or to put it another way, Charles Schumer and some of the other Democrats may be some of the most dangerous people walking around right now.

China is not a stupid country. China is well aware of how the economic world works and no doubt will move towards a G7 existence, given enough time. It's just that right now, China is an agricultural economy that is growing into an indusustrial one. In order to do this, it has to grow at faster rates then established G7 economies, because it needs to create new jobs as it makes the shift.

The shift will happen though.

In the meantime-we need a new word for bubble. This ain't your Dad's 1990's internet-style bubble. What is really is, is a whole bunch of bubbles welded together that floats beautifully because even if one of the little bubbles pops (the US housing market for example), the collective whole is affected to only a small degree. The collective whole keeps floating right along, repairing the damage as it goes.

What should we call that?

I have my guns loaded too though not as heavy caliber as you might have.

I missed the massive sell off last march though but will be extra attentive this time.

I hope you understand i'm not predicting that this will happen, only that if Chinese markets get really nervous what likley will be seen. The trade talks may leave investors feeling very comfortable and allow for carry trades to continue their assent.

We also have this for Wednesday:

http://forexfactory.com/showthread.php?t=30608

US-Chinese talks could be crucial this week.

Despite the widening of the trade band-the Yuan does not figure to appreciate any faster then it has been. That's because the biggest one-day move has only been .16%.

Chinese business concerns operate on razor thin profit margins that would be wiped out by further Yuan appreciation. Some businesses report that a 5% Yuan appreciation coulds wipe them out; other point to as little as a 2 % Yuan appreciation.

If the talks go bad and Chinese investors get nervous, we could see another equity correction in China. That 9% one-day loss roiled global markets and caused a massive unsinding in carry trades as the GBP/JPY lost over 1600 pips and the EUR/JPY about half.

As previously seen, rapid collective carry trade unwinding also causes dollar appreciation vs the GBP, EUR, Aussie and Kiwi and dollar depreciation vs the Yen.

That's the thing I got my gun aimed at-nervous Chinese investors and nervous carry trades. Stay ready.

By the sounds of things, the carry trades could be unwinding as early as this week. Do you think that there could be one last push upwards before we see the unwinding taking place, or will the markets continue to range? I know that this is really hard...more like almost impossible to predict, but from your educated and experienced point of view, do you think that there be one last bull move before we see a fall?

What I plan on doing is staying nuetral while the US-China trade talks are going on. Once outcomes have been established, we should have a better idea about how things will look.

If talks go badly and sentiment goes nervous-carry trades could unwind. If the talks go well, given the overall outlook for the global economy this year-further carry trade borrowing might well occur.

Last Nov/Dec USD Selloff, USDJPY was trading in a very narrow DAily ATR.

After a while, I now realized what that could mean.

Low ATR suggests low volatility not much are put into the carry trades.. Less volatility implies that they could get nervous as well.


So I will look into this low ATR as a possible jitter signs.

I think u have that backwards BK-lower volitility is a green light for carry trades, because it implies less risk. BTW-what's "ATR"?

I wish I would have saved it but BB yesterday had a story that referrenced option volitility and because it was low-it was considered a carry trade green light.

I believe ATR refers to average true range which is suppose to measure the volatility.

Well it seems like the first day of talks didnt have much impact on the carry trades.

The Carry Trade market I don't think looks much at ATR-they're much more concerned with implied option volitility-thanks.

On the contrary-I would say that there definately was action in carry trades today as the dollar lost ground vs the GBP but gained on the JPY. That's a sure sign of buying into carry trades.

Yes you are right there was some upward movement on the GBPJPY which i was hoping for. I was looking for that last move upwards (hopefully). The 240 area seems to be a good resistace area. Now all that is left is for the China-US talks to go sour to shake the carry trades.

This is what I was talking about regarding volitility and carry trades:

``The interest-rate differential story is talking, pushing down the yen,'' said Koichi Yoshikawa, head of currency trading at BNP Paribas in Tokyo. ``The yen's weakening trend is likely to continue'' to 122 a dollar today.

A moderation in currency swings also sustained investor appetite for borrowing yen to buy higher-yielding assets in so- called carry trades. Volatility on one-month yen options was 6.35 percent today, down from 7.50 a month ago.

It appears that lower option volitility is a positive sign for carry trade positions.

If you've been following me in the N&A section, you know that I was focusing on the BoE minutes as a potential trade. So there I was at 4.00AM this morning with my coffee and analysis and as it turned out, I thinkfully did very well. I didn't realize how well I could do though, because I really didn't take one factor into consideration. Lesson learned for the next time.

It's a factor that we hear about all the time, but it often gets overlooked. There's no technical indicator for it and evaluating it is not an exact science, yet you can see it in the charts. It's something you can develop a feel for, but you need to know the "history", or at least the recent history. It's not a fundamental either, in the sense that it isn't "news".

The missing factor is the price and whether the information you are looking for has been "priced in" to the current market value of what you're trading.

What I was looking for was whether the BoE minutes would reflect a strong possibility of another increase. Turns out that they did. (If you don't know what to look for yourself, let me suggest that you go to the calender and check for threads that have been linked to the specific news item. You'll find plenty of good threads there that will tell you what the market is looking for and thereby what you need to be looking for).

Back to today's trade. If you look at the past several weeks of GBP/USD price, you'll immediately see how the dollar has improved. There's a lot of fundamental reasons why that happened and they are well covered in the News and Analysis section so I won't go into them here but the point is, by looking at recent price movement, you could of gotten a pretty good idea about whether hawkish minutes had been priced in or not.

Or you can look at it this way: The pound was worth over 2 bucks when the market didn't have a good idea about future Boe moves. It should be worth something near to that if and when they do. What was it worth today before the minutes came out with that info? Nowhere near there. The new info wasn't priced in.

It does take a fair bit of study to be aware of these things but I think it's worth the effort because it's a big help in trading. There's a lot of info here on the forum, so use it.

If you're lookin at the charts and seeing the big candles and trends, you're probably wondering how to get in on those movements. I sure was back when I started trading 3 weeks ago (just kidding). Put in the time, use what's here and pretty soon, a lot more pieces are gonna start fitting into the puzzle for you.

I hope you're reading my posts in the News and Analysis section:

http://forexfactory.com/forumdisplay.php?f=8

It's interesting for today. If the durables and housing print in the same direction (let's say up in this case) since the GBP/JPY sold off last night after the Greenspam comments-if we were lucky enough to get some good numbers, GBP/JPY should do very well, because this new, positive info wouldn't have been priced in.

We'll see how it goes-we got some good durable numbers so keep your fingers crossed for some good housing numbers.