CTA, FX Fund Manager Market Overview

FX Market Overview – June 16, 2010

Foreign exchange trading and the use of leverage involve a high degree of risk. That’s why we trade our portfolios generally unleveraged, which will be discussed in some of our posts.

I'm a registered CTA and manage fx portfolios for private and institutional clients worldwide.

Be sure to read my document: “Face the Trader Within”

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General Overview

At present, our primary focus is trading AUDJPY and AUDUSD. We work with a range of clients taking advantage of low interest rates in JPY and USD to employ strategies in AUD’s, including real estate development and other projects. In FX, money seeks yield in the longer term, as fx flows have proven over time. We also trade the other majors, but we have excellent trading and risk models for the AUD crosses in the current environment that are working well.

Our current view (June 16) on “risk” (when equities and risk currencies rally) is that we anticipate another round of “risk aversion” (Equities, AUD spot ref .8650 and other risk currencies will fall) in the coming months. We have trimmed down our AUD long positions against both USD and JPY and hope to see lower levels to trade and accumulate positions. We may see AUDUSD as high as .8800. A breach of AUDUSD .8800 would slow our short term trading while re-evaluating the environment. In the event of a double dip contraction, which we view as highly possible, and RBA interest rate cut is not out of the question, but rates will remain in AUD favor over the long haul. We will keep you informed of our general medium and longer term views as the environment changes and discuss our position adjustments. Our methods are quite simply rooted on the back-drop of interest rates and interest rate spreads as we follow monetary policy changes closely.

Near term… risk news is likely to be fueled by Spanish Banks stress tests. There has been some argument over the transparency of the results, but we know what that means. The negative elements of the stress test will be non transparent, while the positive will be ingeniously scripted to elicit a positive view of the downtrodden region of the Eurozone, thus sparking a feel good rally in EUR and equities, on the heels of which, will cause further upside potential for AUD and other risk currencies, although we hope this is not the case.

Market Review in Detail

The Eurozone crisis continues to play out in a similar way to the Asian Crisis of 1997/1998 when Asian currencies were beaten down. We have been bearish Euro since the 2008 crisis suggesting Eastern European bank risk and other structural deficiencies could take it down, only to see it rally to 1.50 before our views played out. During the Asian crisis, global markets were sharply affected by the events as we have seen investor sentiment hit by Europe's developments in Q2'10. It’s about time. I travel frequently to both Asia and Europe and witnessed Italy experience 100% inflation in four years at the onset of the Euro. We could see where this was going. We remain bearish the Euro. In relative terms and Purchasing Power Parity levels are still overweight Euro. We will continue sell the EUR/USD and EUR/CAD on rallies and watch closely the pace of monetary tightening in Canada, which will likely be slower than the market currently is pricing in.

There is no saying how long these curves can last before they correct, like in the late 1990s, and leading into the well overdue 2008 crisis, which was years in the making. As we have been saying for months, the Fed will not begin raising rates until 2011. Fed rhetoric and analysts expectations for mid 2010 was a just the Fed using verbiage to buy time in developing a firm market expectation on policy. We believe this remains inconclusive as another bout of risk aversion is threatening.

Traders should operate within their trading and risk models and look to sell rallies in the euro against the dollar and franc. The structural euro downtrend remains intact as Eurozone members tighten fiscal policy to the detriment of growth, and the ECB is forced to keep buying government bonds. We ultimately expect the commodity and Nordic currencies to recover lost ground in the long run, but not before another heat seeking fall in equities and risk aversion in the coming months.

Federal Reserve Chairman Bernanke has asked Vice Chairman Kohn to delay his departure until September to allow San Franciso Fed President Yellen to be confirmed in time as Kohn's replacement. This will keep the dovish Kohn on the FOMC until the equally dovish Yellen takes his place on the Fed Board of Governors. With turmoil continuing in the Eurozone, UBS US economics team have pushed back the start of their first Fed hike forecast to January 2011 now.

Why Euro is Fragile


The Fed reported that no central banks including the European Central Bank used its dollar swap line facility last week. This was good news for the euro. The euro was also helped by President Trichet helping to calm nerves at his monthly press conference after the ECB board kept interest rates unchanged. Trichet confirmed the ECB would continue to buy government bonds. He also said the ECB 3mth liquidity auctions would be extended, reducing fears that Eurozone banks wouldn't be able to borrow at the ECB if they were shut out of inter-bank markets.

But UBS Fixed Income Strategists expect near term bond spread tightening within the Eurozone will only continue if the ECB keeps buying paper. Last week the European Union finance ministers formally approved the European Financial Stability Facility. This EUR440bn fund was set up as part of the EUR750bn package of support announced in May. The EFSF will issue bonds to support distressed Eurozone member countries that find they can't borrow in the financial markets. This is separate to the EUR110bn package of support agreed for Greece earlier. The good news is parliamentary approval is not required for EFSF to disburse funds to countries in distress. But the bad news is that using the EFSF will be conditional on IMF intervention. According to Stephane Deo, UBS Chief European Economist, that means countries like Spain or Portugal will only seek to use the facility as a very last resort.

This is one of the reasons why the Eurozone bond market remains fragile despite ECB purchases. In addition the EU still has not agreed to make public the result of Europe's stress tests for banks as America did last year. (Of course, authorities are likely taking the necessary time out to jiggle the statistics and generate masterful verbiage that would ultimately elicit a positive market view, and response, concerning the EMU, which would be EUR positive short term). Coupled with fiscal tightening demanded by Germany, Eurozone growth prospects remain weak. That keeps us bearish on the euro. As an alternative position, we’re holding 6mth EURUSD 1.10/1.00 put spreads, in the event of extreme move.

At his press conference, Trichet was asked if euro moves had been 'brutal'. This is the code phrase he used in 2004 to stop the sharp rise of the euro against the dollar. Trichet sidestepped the question, reinforcing our view that the prospect of intervention to stop the slide of the euro remains slim for now. At 1.21 EURUSD is too close to its long term fair value of 1.20 to justify currency market action.
Be sure to read my document: “Face the Trader Within”

http://www.forexfactory.com/misc.php...hments&t=59329

We’re Selling JPY against High Yielders on Bouts of Risk Aversion.
Next week, the Bank of Japan meets. But there is unlikely to be any surprises for the market. Instead investors should focus on new Prime Minister Kan's plans for Japan's public finances. Kan claimed that Japan risks a default if it continues to neglect its fiscal situation. As such his new administration will agree a fiscal consolidation plan on June 22 and present it at the next G20 meeting on the weekend of June 25-27. A credible plan here would help risk sentiment globally by reducing the threat of another downgrade to Japan's ratings. We are bearish JPY long term and will be buying AUDJPY, USDJPY, CADJPY and NZDJPY while welcoming a sharp risk averse rise in JPY to set up Intraday, Swing and Position trades.

NZD and CAD

The Reserve Bank of New Zealand became the fourth G10 central bank to resume tightening when it hiked its official cash rate by 25bps to 2.75%. UBS economists expect the central bank will continue to gradually raise interest rates further depending on how developments in the Eurozone play out. The RBNZ statement pointed out that the increase needed in the cash rate would be less than previous cycles because of higher bank funding costs, long term interest rates being higher than short term rates and the increased use of floating rate mortgages.
In the commodity bloc we continue to favour the Canadian dollar. Bank of Canada Governor Carney welcomed the recent strong jobs numbers and argued that spillovers into Canada from Europe had been modest so far. In contrast Reserve Bank of Australia Governor Stevens warned the Europe crisis may affect business and consumer confidence. He also stressed again the RBA cash rate at 4.5% was at normal levels now. Australia's May labor report did come out again better than expected. And China's raft of monthly data showed strong exports, housing starts, bank lending, industrial production and retail sales. But near term the Australian dollar remains most at risk amongst the commodity bloc if risk-aversion rises again globally. We welcome a fall in confidence accompanied by a sustained pullback in equities to set up long term carry positions.

SDR to Include AUD and CAD?

Longer term, though the picture for both the Australian and Canadian dollars is likely to be supported by continuing central bank reserve diversification into commodity currencies. The IMF will release its five year review of the composition of its Special Drawing Rights basket. The next review takes place at the end of 2010. It is likely that the currency basket of 44% dollar, 34% euro, 11% yen, 11% sterling is revised to include the two largest commodity currencies. This would boost the Australian and Canadian dollars as central banks globally over time shift to using the SDR basket as a benchmark for the composition of their foreign exchange reserves.

Be sure to read my document: “Face the Trader Within”

http://www.forexfactory.com/misc.php...hments&t=59329

Thank you for your post,there are appreciated.

great help ... please come back and write everyday

Eurozone Risks Likely to Continue Longer Term

To recent inquiries, I want to reiterate the importance of engaging the trading exercises as critical to building a structured approach to trading. The more you focus on the details, the more unforeseen details will emerge as you build a foundation in trading that will become internalized and remain with you as long as you are trading (which is as long as you manage your risk effectively).

Put it this way... If it takes you 30 days to run an exercise sample size of 100 and you improve your understanding of market structure in a specific area by 20%, you are much further ahead than if you are to take random trades that cost you $2000 drawdown resulting in no deeper understanding of market behaviour. Think about it.Jumping into trades with no structure will probably not be sustainable as the information is shallow in your my and internals. Stay the course and develop methodically. System thinking. Structure. Exercises. Stay the course.

For months, we have shared our view to short EURUSD on rallies above 1.4000. When we take longer term positions, profit is often taken on a percentage of the position should price move swiftly in our favour. This opens the possibility of lowering/raising our average entry level as equity is locked into the position. Furthermore, the approach reduces the risk should price move in our disfavour. We are also in a position long USD/CAD spot ref 1.0170, a classic example of using early price spikes to withdrawal equity and re-enter same position size at lower levels should the market open the door.

European government bond yields have not reached alarming levels, though it is clear that the currency union is still very far from finding a structural solution. Germany and France still cannot agree on the functions of the EFSF and it appears momentum is gathering for yet another round of talks aimed at a 'comprehensive solution'. Recent US data was headline inflation has fallen to 3.5%, more than expected while core inflation was steady; capital flows into the US surprised to the upside and industrial production (+0.7%m/m) also registered a positive surprise. Although these points are still not enough to turn the US into a growth currency, the sustained flow of capital into the US to capture stronger growth will surely pick up speed if such numbers can be maintained and yield spreads move in favour of USD. The Bank of England released its quarterly inflation report, downgrading both its GDP and CPI outlooks. The report stated that inflation is likely to be below target in the next two years and the outlook for growth is unusually uncertain. Growth is expected to be markedly weaker than the Bank had previously thought. This divergence will see selling of GBPUSD. Although we acknowledge that short positions are heavy, event-based short covering over the past two weeks has re-opened the path for fresh downside. Mario Monti was formally sworn in as Italian prime minister with a technocratic cabinet, and we believe he will need to race against time to come up with comprehensive plans to turn around Italy's debt situation, although unlikely. I don't believe you can, in real terms (non intervention) turn around a problem with a new cabinet, in 2 weeks, which has taken 10 years to create. Let's give our heads a shake, shall we? Although all is, for the interim, doom and gloom for Eurozone, this does not mean the EURUSD could not, or would not, rally to 1.4800. We are not married to our positions.

Spreads in the Eurozone periphery tightened versus Germany, although these moves were largely consolidating the large moves seen over the past two days. The euro followed price action in the fixed income markets, stabilizing after two heavy days.

France appears to be maintaining its position that the EFSF should be given a banking license. In comments made on Nov 16, he said this would be the best way to create a structural firewall around the Eurozone and to prevent contagion. However, French Finance Minister Baroin said that "Germany has reservations that are more than historical, almost sociological and structural, concerning such an intervention from the central bank". Indeed, Germany's deputy finance minister flatly ruled out such an approach, saying "it is essential that the EFSF cannot tap the ECB". Common among politically tied entities, a reinterpretation of the "laws" is not unlikely. Do you recall playing a game with a family member or friend and they change the rules mid course to give themselves an edge. We used to see a lot of this while bobsledding. As our non European nation began to move up the world ranks of a European dominated sport, the efforts made to give themselves an advantage on their own turf became increasingly apparent. It's called human behavior and common symptoms are seen in the masses. Our job as traders is to take a view of how we believe the market will perceive, and respond to, forthcoming events. We are not making "predictions." We are traders who view our parameters objectively and remain open to the constant changes in the market. We are working with human behavior. As a side not, we went on to win the Overall World Cup, the first Non-European nation to do so, and managed to change the traditional ways of the sport.

In a report, Fitch ratings agency said the outlook for US banks could materially worsen if conditions in the Eurozone were to deteriorate. However, the agency acknowledged that US banks had significantly reduced exposure to Eurozone banks.

Italian PM Monti was officially sworn in on Nov 16, Eurogoup chief Juncker said he was the 'right man' to reform Italy. However, Juncker expressed some displeasure at Germany, in saying that Germany's debt to GDP ratio was actually larger than Spain's, but "no one wants to know about that".

The Troika review for Portugal was largely positive. The ECB said the mission agreed on program policies and growth in 2011 was better than expected. However, 2012 would be more challenging in growth terms, and warned that the program's success depended on structural reforms. Crucially, the next EUR8bn tranche would be disbursed either in December or January.

The IMF's Europe director resigned without giving details.

The BoE released its quarterly inflation report, downgrading both its GDP and CPI outlooks. The report stated that inflation is likely to be below target in the next two years and the outlook for growth is unusually uncertain. Growth is expected to be markedly weaker than the Bank had previously thought. They see the Eurozone crisis as the biggest single risk to the UK. The fan charts show CPI at around 1.3% in 2 years. Provided that CPI begins to decline as the BoE expects, the scope for further asset purchases is relatively high, especially if conditions in the Eurozone deteriorate further.

The BoJ left policy entirely unchanged at Wednesday's policy meeting, as widely expected.

Finance Minister Azumi said his position is unchanged on FX intervention, and we expect the MoF/BoJ to be on high alert in light of recent volatility.

The Securities Markets Program (SMP) Brain Child...

The ECB's increased purchases of Italian and Spanish paper via the Securities Markets Program (SMP) have raised questions about the limits it might face. The answer is simple: we believe there are no legal or technical limits on the programme and its sterilization.

Under the SMP, the Eurosystem (the ECB and the 17 national central banks of the EMU) buys sovereign paper in the market and prints money to do so. The central bank books the bond purchased under "Securities held for monetary policy purpose, Euro" on the asset side of its balance sheet. Thus the asset side of its balance sheet expands by the amount of the purchase. The bonds are booked at cost, and are not marked to market as they are in a held-to-maturity portfolio.

The counterpart on the liability side is simple money creation: usually the bank of the central bank involved credits the current account of the seller by the amount of the purchase.

From a legal perspective, central banks in the Eurosystem cannot finance a public deficit, which means they cannot buy debt on the primary market. But there is no legal limit to doing so on the secondary market.

From an accounting perspective, the ECB can expand its balance sheet as much as it wishes. Indeed, the Fed, BoE and SNB are doing the same in implementing quantitative easing - for far more substantial amounts than the current SMP.

The ECB sterilizes its bond purchases by borrowing from the market on a seven-day basis, so there is also no limit to its sterilization.

Problems would arise if banks in distress use the SMP to get cash they cannot obtain in the market, while other banks hoarded cash and refused to lend to the ECB. However, a scenario in which banks are so desperate to keep cash that they refuse to lend it to the ECB for just seven days would constitute a major liquidity trap. And in that case, sterilization for fear of inflation would be the last of the worries.

Source: Houdini, UBS, Bloomberg

Interesting. Thanks Chris.