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June 23rd, 2010-Giant#2 FX Market Overview

Discussion in 'Giant #2' started by Giant #2, Jun 23, 2010.

  1. Giant #2

    Giant #2 Former Special Consultant to the FPA

    Jun 19, 2010
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    Giant 2 and FPA hope to bring you regular updates and market reviews, strategies and positions they are running and managing.

    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.

    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 23) 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 so we can accumulate positions. We may see AUDUSD as high as .8800, once more, but we feel the current highs will remain in place for weeks to come. A breach of AUDUSD .8850 would slow our short term trading while re-evaluating the environment. AUD appears to be weakening at time of writing. In the event of a double dip contraction, which we view as highly possible, an 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 short term 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 stating 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’s 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 to 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 (or later if we contact, again). 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 looking 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 bearish EUR longer term.

    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 1.22 EURUSD is too close to its long term fair value of 1.20 to justify currency market action.

    We’re Selling JPY against High Yielders on Bouts of Risk Aversion.
    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 agreed on fiscal consolidation plan on June 22 and will 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. We will post the levels that we are buying. We trade the pairs short, medium and longer term. The short term positions will be hard to follow, since the trades may last only a few hours, as funds buy sharp risk averse moves.

    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. We will be buyers of NZDUSD on moves below .6800 and .6600, hoping to see mid .60’s again.

    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 Careful Out There! G2
  2. Mandrake

    Mandrake Corporal

    Feb 24, 2010
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    Great amount of important information. Thanks a lot G2. Hope to see more of your post here.
  3. lecsolo

    lecsolo Recruit

    Jun 24, 2008
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    Very interesting!!!

    Thanks G2 to share with us all these informations!!!

    Very interesting, I will follow it very closely.
  4. CanAm

    CanAm Private, 1st Class

    Aug 26, 2009
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    Welcome aboard G2
    I have never been a fundamentals person but found your insights very interesting & informative.
    Very well written & easy to follow.
    Have subscribed to hear more on your views.
    #4 CanAm, Jun 24, 2010
    Last edited: Jun 24, 2010
  5. Gilgamesh

    Gilgamesh Recruit

    Feb 28, 2010
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    I guess I must be more dense than most here. I could hardly understand a single sentence of that very abstruse pice of writing, but I am glad to know that some others found it informative. I don't know what "risk aversion" means (not wanting to risk anything perhaps? Is that reasonable in forex trading?), nor commodity currencies, nor a whole lot of other factors mentioned here. I just don't have the intellectual ability to take in all that, it's simply confusing to me. I'll just stick to technical analysis; I know well that it's quite possible to make profits on forex without any knowledge of these economic factors.

    Far more important to me are money management, emotional control, making a plan and following it. If I look after that, I profit; if not, I lose.
    #5 Gilgamesh, Jun 24, 2010
    Lasted edited by : Jul 1, 2010
  6. onenikos

    onenikos Corporal

    Apr 30, 2010
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    I would be interested to know your view on XAUUSD

    It would be very interesting to know your view on both XAU and XAG usd - eur.

    One comment might be the boost of the euro exports and possible inflation with the cheaper eur around parity after 2011. Intervention of IMF is in USD converted to EUR!. I also personally listen very carefully to UBS but at the same time tripple check other sources (which I am sure you do too)

    Anyway, I take my hat off to you Sir. Top work.
    All the best to you
  7. Robert Bumbalough

    Oct 24, 2008
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    Thank you G2. Please know your efforts to educate the FPA user community are appreciated. Best Wishes for Big Profits. :)
  8. dkami

    dkami Sergeant

    Apr 13, 2010
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    Thanks Giant#2 i was so happy to read your first few lines where you mainly trade AUD/USD,AUD/JPY as these are the main currenys i trade(more to the point can understand as an aussie) i look forward to reading your future posts thanks for sharing and thanks Felix For twisting his/her arm:)
  9. write2kc

    write2kc Recruit

    Apr 1, 2010
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    G2 welcome to FPA and thank you for sharing your valuable review and insight. I look foward to your continued contributions here.
  10. Gerhart

    Gerhart Recruit

    May 14, 2009
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    Thank you from Cologne, Germany

    Thank you G2 for your extensive and thorough analysis!
    Living in the midst of Euro turmoil ( in Germany ) I very much appreciate a professional's view on the Euro, in particular because the papers here tend to be too Euro-optimistic or too Euro-pessimistic.
    Some of my friends prepare for a breakdown of the Euro; they buy real estate, gold and Swiss Francs.
    To the benefit of the weaker side of the Euro zone ( "PIIGS" ), we Germans are infinitely eager to cut our own throats to help others out, who will laugh their heads off when Germany goes to the ground.

    Keep up the good work, and thank you again!


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