If I had five minutes to question the top US monetary policy official, I don't think I would ask about Moroccan Pottery or whether US treasury securities are performing assets. I guess that means I won't serving in the Congress, . Such were some of the highlights of Bernanke's two day affair before Senate and House committees.
The gist of Mr. Bernanke's testimony can be summarized as the following. Conservatives who for the most part have a weak grasp of monetary economics bashed the Fed's recent easing actions, presumably because the Heritage Foundation told them they're supposed to hate QE. Then most members asked about the effect of the sequester. Bernanke responded in what seemed like a thousand iterations that short term growth depends on the volume of spending in the economy, including spending by government, and long term growth comes from investments in human talent, industrial capital, and infrastructure by both government but mainly the private sector. The obvious solution is to seek to slowly phase in spending cuts to protect the fragile recovery, while simultaneously pursuing longterm entitlement and other fiscal reforms to stabilize the country's public finances in the out years. It was like he was reading from an Econ 101 textbook. I wonder if it has occurred to Mr. Bernanke to simply send along a copy of the latest edition of his own pedagogical tome to each Congressman who demanded that Bernanke submit written answers to their tired, over-wrought inquiries.
Alas, public self aggrandizement had bipartisan support. The newly elected Senator from Massachusetts, Elizabeth Warren, got testy with Bernanke over the 'subsidy' granted to big banks because they enjoy cheaper borrowing rates on the short term funding market. An IMF paper claims that large institutions pay up to 40 basis points less for very short term funding, a discount attributable only to implicit government guarantees. The term subsidy is a misnomer, since the market is providing the discount, not the taxpayer. Furthermore, it is quite debatable if the discount is attributable to a special 'too big to fail' status of some banks. Most interbank lending still takes place in the context of established relationships between institutions that go back years, rather than through an exchange or an intermediary. Small banks are also a rule have much more liquid cash on their balance sheets as a result of week loan demand, so they might not have the sophistication to seek the best rate when they do need short term financing. Finally, for small banks which may only need to borrow several million dollars overnight, the economic incentive for managers to seek the best rate is minuscule. For example, saving 10 basis points on a 1 million dollars overnight amounts to a paltry $2.74. Therefore, it is unlikely that CFOs of small banks expend much effort to seek the best rates. Finally, it must be noted that one of the Fed's biggest achievements in the past four years has been the stabilization of short term interbank lending markets in the wake of the 2008-09 crisis. In sum, this whole thing looks like just more chest thumping by Ms. Warren as she continues to brandish her bank-bashing bonofides which started her political career in the first place.
Chairman Bernanke for his part impressively maintained his composure, respectfully yet forthrightly responding to the plethora of mostly irrelevant questions, the majority of which brought up as ways for individual members of Congress to grandstand in front of their respective constituencies. However, Mr. Bernanke at times appear to let show a bit of exasperation, at times appearing with a strain look on is face and placing his index and middle fingers on his temple. At the end of the hearing, after an aggressive line of questioning from Sean 'The Real World' Duffy (R-WI), the Chairman could not contain a few chuckles.
On FX, the reaction was largely mute, with EUR edging higher on a few bright signals out of Europe. The USD consolidated its gains against so-called risk-assets following the recent bout of risk aversion. The Yen also held its recent gains. MXN was only big mover, falling to nearly 12.90 to the greenback only to surge 1000 pips on hawkish comments from deputy governor Manuel Sanchez of Banco de México. One USD bought 12.77 MXN as of 7:28 PM GMT.
Wednesday, February 27, 2013
Tuesday, February 26, 2013
Midweek Position Summary (Again)
Forex trading is a rough and fast paced business, and I feel obliged to update readers of sum drastic actions (relatively) that I took overnight during the Asian session. I closed all risk oriented positions, naming my short USD/MXN and long AUD/JPY. I took some losses on the former, but it turned out to be an excellent strategic retreat. The greenback surged nearly 800 pips against the peso this morning, in line with the risk off sentiment gripping the markets. Likewise, I closed AUD/JPY at cost, a move that was also well timed since AUD/JPY is down big this morning as the deterioration of risk appetite has slammed the Aussie and buoyed the Yen.
My motivation for this reshuffling was two fold. First, I saw lack of conviction in the latest risk-on moves in the both the S&P 500 and the FX market, as evidenced by big gains followed by even larger pullbacks. Secondly, the recent carnage has presented a rare opportunity to make a big move with limited downside. EUR/CHF has been trading in the 1.2150-1.22 range, kissing an overnight low of 1.2117. Because downside is limited to the 1.20 cap set by the SNB (Switzerland's central bank), there exists a great opportunity for some highly leveraged arbitrage. Specifically, I plan to trade around a core long position of EUR/CHF and with orders on the way down towards the 1.20 firewall. The very modest positive carry, along with the simple mechanical fact that this pair can really only go up, makes it possible to employ much more capital, with a chance for great gains and limited downside. Even leveraged 50:1, the pair could drop to the floor and I would still have nearly twice the required equity to cover the margin. That's not to say I shot all my bullets at once however. Right now I am all in on EUR/CHF, with a 10:1 debt to equity ratio. I will target 1.23 in the short term, and if EUR/CHF goes down, I'll buy more.
My motivation for this reshuffling was two fold. First, I saw lack of conviction in the latest risk-on moves in the both the S&P 500 and the FX market, as evidenced by big gains followed by even larger pullbacks. Secondly, the recent carnage has presented a rare opportunity to make a big move with limited downside. EUR/CHF has been trading in the 1.2150-1.22 range, kissing an overnight low of 1.2117. Because downside is limited to the 1.20 cap set by the SNB (Switzerland's central bank), there exists a great opportunity for some highly leveraged arbitrage. Specifically, I plan to trade around a core long position of EUR/CHF and with orders on the way down towards the 1.20 firewall. The very modest positive carry, along with the simple mechanical fact that this pair can really only go up, makes it possible to employ much more capital, with a chance for great gains and limited downside. Even leveraged 50:1, the pair could drop to the floor and I would still have nearly twice the required equity to cover the margin. That's not to say I shot all my bullets at once however. Right now I am all in on EUR/CHF, with a 10:1 debt to equity ratio. I will target 1.23 in the short term, and if EUR/CHF goes down, I'll buy more.
Monday, February 25, 2013
Midweek Position Summary
Portfolio Composition
Long EUR/CHF 16.67 percent
Short USD/MXN 25 percent
Cash 58.33 percent
Heightened market uncertainty, on the back of murky results from Italian elections and ahead of Bernanke's testimony, has caused a violent reduction in risk sentiment. The Yen appears to be the big winner in all this, resuming its status as safe haven as the markets wait with baited breath. The recent pullback caused me to book some sizable losses on some short JPY positions, but I am looking to get back in after the market settles down. The announcement of ultra dovish Haruhiko Kuroda as the next head of the BOJ sent the Yen tumbling last night in Asia, with USD/JPY touching 3-year highs, only to violently pullback.
EUR/JPY is down an astonishing six big figures, or 4.8 percent in a single trading session. A It's days like these that make me want to stick to carry trades with undervalued EM currencies like MXN.
Long EUR/CHF 16.67 percent
Short USD/MXN 25 percent
Cash 58.33 percent
Heightened market uncertainty, on the back of murky results from Italian elections and ahead of Bernanke's testimony, has caused a violent reduction in risk sentiment. The Yen appears to be the big winner in all this, resuming its status as safe haven as the markets wait with baited breath. The recent pullback caused me to book some sizable losses on some short JPY positions, but I am looking to get back in after the market settles down. The announcement of ultra dovish Haruhiko Kuroda as the next head of the BOJ sent the Yen tumbling last night in Asia, with USD/JPY touching 3-year highs, only to violently pullback.
EUR/JPY is down an astonishing six big figures, or 4.8 percent in a single trading session. A It's days like these that make me want to stick to carry trades with undervalued EM currencies like MXN.
Tuesday, February 19, 2013
Tuesday, February 12, 2013
Commentary: EUR is Over-Bought in the Short Term
The two major events of the FX market for the past several months have been the surging Euro and the imploding yen. Both events have had distinct drivers, namely, the easing of the European sovereign debt crisis on the Continent, and the new LDP government's plans to enact a program which finally ends deflation in Japan. It my judgment, the first of these trends will reverse somewhat, with the Euro ending the year in a 1.25-1.27 range against the greenback. The yen on the other hand will continue its slide. I expect USD/JPY to end the year at 105.
Europe: The End of the Beginning
The summertime headlines foretelling the inevitability of Greece leaving the Eurozone have all but disappeared from the financial press. Certainly, the tail risk of a catostrophic break up of the Eurozone drives gloomy sentiment, and the dissipation of this risk is supportive of the Euro. However, real progress has been made in Europe since the summer on one very important front -- sovereign debt markets are functioning again. Gone are the seven percent yields for Italian bonds which made it virtually impossible for Italy to balance its books due to the skyrocketing cost of its debt service. Yields on Spanish, Portuguese, and Greek debt are down too, due to the implementation of credible austerity plans and support from the IMF, EU, and ECB. The bottom line is that with the chaos on sovereign debt markets abating, the European economy has the potential to grow again. That's not to say its growing now, indeed it is forecast to shrink by 0.4 percent this year. However, Europe has escaped fate of being trapped in eternal economic limbo. Now Europe needs to show that it can post solid economic performance again.
Thus for Euro itself, the outlook remains negative, at least in short term. With its economy still shrinking, European investment outlets remain much less attractive than their counterparts in the Americas and Asia. Furthermore, the fiscal consolidation which has brought about a stabilization in the Eurozone sovereign debt markets will continue to work its way through the economy and will remain a significant headwind to growth for some time. The vicious cycle of ever rising debt service in the periphery countries has ended. However, the cost, fiscal tightening at the expense of growth, means that it will years before these countries can safely use the capital markets to finance fiscal stimulus to promote growth, lest they risk all the progress thus far made.
Therefore, though the catastrophe has been averted, much pain and further work still lies ahead. In the words of PM Churchill, a champion of European integration who called for a "United States of Europe," "It's not end, it's not th beginning of the end. But it is the end of the beginning."
In sum, the recent rally in the Euro, caused by a dissipation of catastrophic tail risk, will fade as the relief of many investors have over the probably survival of the Eurozone runs into the reality of weak fundamentals, and strong macro-economic headwinds such as fiscal drag at all levels of government, and monetary policy which is already about as accommodative as it can get. Overnight rates for Euros are already about 13 bps lower than for USD. The ECB, unlike the Federal Reserve, does not target overnight rates as the main instrument of monetary policy. Instead, it influences the money market by adjusting the rate at which it lends to Eurozone banks via its weekly repo transactions. The result is that its distinct policy rate, currently at 0.75 percent, has resulted in even cheaper money market rates than in the US. Therefore, the key policy rate for Europe is already close to its lower bound.
To be sure, Europe is still a rich and vibrant society which enjoys countless structural advantages over most other economies, namely its political stability and educated populace. Europe will comeback, but in the next year, in light of many challenges it still faces, EUR is going to dip to 1.27 per greenback in the coming year.
Europe: The End of the Beginning
The summertime headlines foretelling the inevitability of Greece leaving the Eurozone have all but disappeared from the financial press. Certainly, the tail risk of a catostrophic break up of the Eurozone drives gloomy sentiment, and the dissipation of this risk is supportive of the Euro. However, real progress has been made in Europe since the summer on one very important front -- sovereign debt markets are functioning again. Gone are the seven percent yields for Italian bonds which made it virtually impossible for Italy to balance its books due to the skyrocketing cost of its debt service. Yields on Spanish, Portuguese, and Greek debt are down too, due to the implementation of credible austerity plans and support from the IMF, EU, and ECB. The bottom line is that with the chaos on sovereign debt markets abating, the European economy has the potential to grow again. That's not to say its growing now, indeed it is forecast to shrink by 0.4 percent this year. However, Europe has escaped fate of being trapped in eternal economic limbo. Now Europe needs to show that it can post solid economic performance again.
Thus for Euro itself, the outlook remains negative, at least in short term. With its economy still shrinking, European investment outlets remain much less attractive than their counterparts in the Americas and Asia. Furthermore, the fiscal consolidation which has brought about a stabilization in the Eurozone sovereign debt markets will continue to work its way through the economy and will remain a significant headwind to growth for some time. The vicious cycle of ever rising debt service in the periphery countries has ended. However, the cost, fiscal tightening at the expense of growth, means that it will years before these countries can safely use the capital markets to finance fiscal stimulus to promote growth, lest they risk all the progress thus far made.
Therefore, though the catastrophe has been averted, much pain and further work still lies ahead. In the words of PM Churchill, a champion of European integration who called for a "United States of Europe," "It's not end, it's not th beginning of the end. But it is the end of the beginning."
In sum, the recent rally in the Euro, caused by a dissipation of catastrophic tail risk, will fade as the relief of many investors have over the probably survival of the Eurozone runs into the reality of weak fundamentals, and strong macro-economic headwinds such as fiscal drag at all levels of government, and monetary policy which is already about as accommodative as it can get. Overnight rates for Euros are already about 13 bps lower than for USD. The ECB, unlike the Federal Reserve, does not target overnight rates as the main instrument of monetary policy. Instead, it influences the money market by adjusting the rate at which it lends to Eurozone banks via its weekly repo transactions. The result is that its distinct policy rate, currently at 0.75 percent, has resulted in even cheaper money market rates than in the US. Therefore, the key policy rate for Europe is already close to its lower bound.
To be sure, Europe is still a rich and vibrant society which enjoys countless structural advantages over most other economies, namely its political stability and educated populace. Europe will comeback, but in the next year, in light of many challenges it still faces, EUR is going to dip to 1.27 per greenback in the coming year.
Tuesday, February 5, 2013
Confessions of an FX Trader: Volatility Reigns
Trading is about what you don't lose, not what you make.
-- Market Maxim
The awesome volatility on the FX market has meant that some traders have made a lot of money in the past few weeks. It also means that scores of speculators have also lost their shirts and may have to hang up their hats entirely. My sincere condolences to the Euro bears. I am still looking to fade the pop, given the poor underlying fundamentals, but it will take a monumental shift in the overall tone of before I will be short EUR again. Right now, despite poor growth and lingering debt problems, the break up of the Eurozone is being 'priced out' of the market. In short, the dissipation of this tail risk is causing the Euro to surge even as the economies that underly it continue to struggle.
New information being priced into the market means volatility. Several major pairs have been moving ~2 percent per day. A quick back on the envelope calculation will reveal the staggering profits (or losses) to be realized in such a market. A 100000 unit long position on EUR/JPY, purchased at yesterdays low of 124 and sold at today's high of 127.41 would have yielded single session profit of $3648.7. Given that this position could be initiated with 50:1 leverage, or by putting up only $2000, that's a 12 hour return of roughly 160 percent.
It's hard not to sit in awe of these numbers, especially when you have the margin available to theoretically make these trades. My only consolation is that nobody is a superman able to perfect time the market, calling the day's highs and lows, and betting everything on them.
For my part, I have had my ups and downs and taken my licks. I grudgingly booked a 300-pip post Draghi loss on a short EUR/USD position in early August. True, I could have hung on and found a slightly better exit point, but if I had been unwilling to admit that I had been wrong on the Euro, at least in the short to medium term, the dreaded margin calls would have come in the late fall. I ended up walking away with a slight profit for the summer on my short EUR activity. Making the money was the easy part, any fool could see things deteriorating in the Eurozone in June and July. Where I went wrong was not being able to avoid losing my profits when the market shifted.
My willingness to admit defeat allowed me to move on to other deals. I was able to pick myself up and rebuild my Empire. I went back to basics, taking cautious positions mainly long MXN, and made most of my money on positive carry. Since then, I have jumped on the short JPY bandwagon, and even went long EUR/JPY a few times. My entry exit points have not been perfect by any stretch, but I have locked profits and continue to earn an excellent return relative to stocks or other assets. It's fun at times fantasize about what could have been, if positions had been bigger, and timing been better. For it is in our dreams that fortunes are made. And lost.
-- Market Maxim
The awesome volatility on the FX market has meant that some traders have made a lot of money in the past few weeks. It also means that scores of speculators have also lost their shirts and may have to hang up their hats entirely. My sincere condolences to the Euro bears. I am still looking to fade the pop, given the poor underlying fundamentals, but it will take a monumental shift in the overall tone of before I will be short EUR again. Right now, despite poor growth and lingering debt problems, the break up of the Eurozone is being 'priced out' of the market. In short, the dissipation of this tail risk is causing the Euro to surge even as the economies that underly it continue to struggle.
New information being priced into the market means volatility. Several major pairs have been moving ~2 percent per day. A quick back on the envelope calculation will reveal the staggering profits (or losses) to be realized in such a market. A 100000 unit long position on EUR/JPY, purchased at yesterdays low of 124 and sold at today's high of 127.41 would have yielded single session profit of $3648.7. Given that this position could be initiated with 50:1 leverage, or by putting up only $2000, that's a 12 hour return of roughly 160 percent.
It's hard not to sit in awe of these numbers, especially when you have the margin available to theoretically make these trades. My only consolation is that nobody is a superman able to perfect time the market, calling the day's highs and lows, and betting everything on them.
For my part, I have had my ups and downs and taken my licks. I grudgingly booked a 300-pip post Draghi loss on a short EUR/USD position in early August. True, I could have hung on and found a slightly better exit point, but if I had been unwilling to admit that I had been wrong on the Euro, at least in the short to medium term, the dreaded margin calls would have come in the late fall. I ended up walking away with a slight profit for the summer on my short EUR activity. Making the money was the easy part, any fool could see things deteriorating in the Eurozone in June and July. Where I went wrong was not being able to avoid losing my profits when the market shifted.
My willingness to admit defeat allowed me to move on to other deals. I was able to pick myself up and rebuild my Empire. I went back to basics, taking cautious positions mainly long MXN, and made most of my money on positive carry. Since then, I have jumped on the short JPY bandwagon, and even went long EUR/JPY a few times. My entry exit points have not been perfect by any stretch, but I have locked profits and continue to earn an excellent return relative to stocks or other assets. It's fun at times fantasize about what could have been, if positions had been bigger, and timing been better. For it is in our dreams that fortunes are made. And lost.
Friday, February 1, 2013
News: Markets Calmed as NFP Meets Expectations, Peso Higher
More evidence emerged today that the 0.1 percent contraction measured in the fourth quarter of 2012 was indeed due to the biggest reduction in defense spending since 1972. Nonfarm payrolls, the so-called monthly jobs report, came in this morning at 157,000, slightly above the 155,000 median estimate by analysts. Steep defense cuts had caused military spending to fall by 22 percent quarter on quarter, a fiscal adjustment which appears to help explain the sudden halt to economic growth in the fourth quarter. Consumer spending rose 2.2 percent in the fourth quarter, compared to 1.6 percent in Q3, while business investment also saw a modest uptick. The effect of the expiration of the temporary payroll tax cut at the beginning of this year, along with whatever further cuts agreed on by the White House and Congress to avoid the secuester, remain as the biggest macro-economic risks in short to medium term. However, a temporary moderation of growth after a fiscal tightening is hardly a shocking economic result.
As such, markets have largely shrugged off the headline Q4 contraction in light of the strong data coming out of the private sector. Today's jobs number, coming in as expected, further calmed markets. MXN is up, settling into a tight range around 12.64 after USD/MXN kissed 12.75 overnight in Asia. The Canadian dollar has also fought its way back above parity with its US counterpart, with USD/CAD trading in a 0.9980 to 1.0000 range.
The Euro continues its incredible run, with one Euro purchasing 1.3669 USD as of 6:06 PM GMT. Conversely, a fresh wave of Yen weakness has USD/JPY poised to test the 93 level. The pair has tested fresh highs today, touching nearly 92.7 before retreating back towards 92.5. USD/JPY began this week at 90.8. In sum, the continuation of the major trends seen since last fall confirms that markets remain confident despite the recent GDP hiccup.
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At the same time, in PPP terms, emerging market currencies continue to trade at a discount. Certainly, demand for assets denominated in emerging market currencies is also a huge driver of FX rates, and ultimately is a reflection of investor risk appetite. Therefore, it will be interesting to see how emerging market currencies behave in the next five years. The Fed will almost certaintly keep rates low until in hits its 6.5 percent unemployment threshold. From here until then, risk appetite is bound to increase as the economy continues to chug along. At the same huge interest rate differtials will continue to persist. So in the short to medium term, emerging market currencies look well positioned for further gains. When the Fed finally starts unwinding its balance sheet, probably around 2017, some capital will come home, but investors will still look to emerging markets for growth, barring some meltdown, for decades to come.
However, taking into account the two major factors which drive emerging market FX, namely yield differentials and demand for assets denominated in EM currencies, it would be wise to invest selectively. INR and ZAR are trading at huge discounts in PPP terms against the dollar. This fact however probably does not make either of these currencies attractive longs, as both India and South Africa continue to face big challenges that threaten future medium term growth. India has disastrous government finances, high inflation, and a growing current account deficit. South Africa faces internal labor and political strife, growing twin deficits, falling precious metal prices, and weak demand in its main export market, Europe. So in short, despite what the Economist's Big Mac index says about these currencies, they are trading at a discount for a reason. The fact that significant downside risks have been priced into these currencies does not make them 'undervalued.' If anything, I seen the Rand falling even further, perhaps even to 10 to the USD.
In sum, the secret to playing emerging markets are research, due diligence, and patience. EM currencies are riskier than majors, since the underlying economies are more vulnerable to both internal and external shocks. The key is take advantage of this risk premium while minimizing potential downside. This can only be done by copious amounts of investigation and homework into the EM currency which catches your fancy. Do not fear risk, embrace it, and channel your passion into the enhanced due diligence required to take greater risks. And reap the rewards.