Forexinvestorz.com – By Forex Investorz for Forex Investorz!

Emerging Markets Rally, Despite Eurozone Debt Crisis

It looks like emerging market investors took my last post (“Investors” Shouldn’t Worry about the Euro) to heart, since emerging markets (EM) have continued to rally in spite of the Euro’s woes. To be sure, EM stocks, bonds, and currencies all dipped slightly in May when the crisis reached fever pitch, but they have since recovered their losses and are once again en route to record highs.

MSCI Stock Index 2010

That’s not to say that that surge in risk-aversion wasn’t justified. In fact, investors are continuing to punish the Eurozone as well as a handful of other risky areas. However, analysts have concluded that in the case of emerging markets as a whole, this mindset doesn’t really make sense.

Simply, the fiscal and economic condition of is stronger than in developing countries. Whereas previously crises were known to originate in developing countries and spread to industrialized countries, this latest series of crisis turned that notion on its head. The credit and housing crises were largely the product of speculation in the West, and the sovereign debt crisis originated in Europe. While it’s possible that investor concern would self-fulfillingly cause the crisis to spread to emerging markets, any impact would probably be muted.

EMBI+ bond index 2011
As far as forex investors are concerned, the confidence in EM capital markets should also extend to currencies. The carry trade is heating up (thanks to the cheap Euro), and will probably only expand as EM Central Banks move to raise interest rates to combat inflation, as alluded to above. If the Eurozone debt crisis intensifies, then you can expect some kind of pull-back. As with recent retracements, however, it will be only temporary.

Post Details
Posted on July 23, 2010
at 10:47 am
Written / posted by: Simon
Filed under: News, Sharp Observations, forex trading

Since the beginning of June, the Euro has rallied by an impressive 8% against the US Dollar, and by comparable margins against other currencies. The question on every one’s minds, of course, is whether this represents a temporary pullback or a permanent correction.

EUR USD 3 months 2010
The arguments in favor of the former are pretty strong. Namely, EUR/USD bearish sentiment had expanded to such an extreme level that a pullback – temporary or permanent – was basically inevitable. From this standpoint, what we have seen unfold over the last month-and-a-half is a classic short squeeze. Basically, those who were short the Euro were forced to cover their positions when it started to rally, which in turn triggered more selling, and ultimately, a self-fulfilling rally. As a result, “The difference in the number of wagers by hedge funds and other large speculators on a decline in the euro compared with those on a gain dropped to 38,909 on July 6, compared with record net shorts of 113,890 on May 11.”

Due to its sudden rise, the Euro became a much less attractive funding currency for carry traders. It helps that other Central Banks are delaying interest rate hikes, which means it’s difficult to turn a solid profit (on a risk-adjusted basis) from shorting the Euro. In addition, the markets have started to turn their attention to economic fundamentals in the US, which had been edging out the Euro in one of the perennially important rivalries in currency markets. In short, it suddenly became obvious to traders that the economic and fiscal conditions in the US are at best equal to those in the EU.

Finally, there was an implicit acknowledgement among the EU leadership that the so-called sovereign debt crisis is actually in many ways a banking crisis. This admission came in the form of stress-tests on 91 of the EU’s largest banks, designed to determine their exposure to sovereign debt and placate investors. After all, “It was German and French banks that led the way in lending to Greece or Spain.” This misjudgement has spurred such banks to set aside Billions in potential losses and vastly curtail their lending activities.

Unfortunately, investors are skeptical that the stress tests will be stringent enough, seeing them as a mere publicity stunt: “While the EU have tried to counter these suspicions by promising to publish the result of stress tests, the market is fearful that stress tests will force some banks into writing down losses on non-performing loans.” By extension, investors are still equally concerned about the possibility of a sovereign debt default, even one that it is only partial.

In other words, the consensus is that despite the EU’s best efforts to tackle the crisis, it still has yet to enact meaningful structural reforms, opting instead for short-term stopgap solutions. According to The Economist, “The debate about how to save Europe’s single currency from disintegration is stuck…because the euro zone’s dominant powers, France and Germany, agree on the need for greater harmonisation within the euro zone, but disagree about what to harmonise.” There remains a lack of agreement over whether the economically and fiscally weaker members of the EU will be allowed to remain members, and if so, what if anything will be done to keep them in line.

EU Public Debt

As you can see from the chart above, time is quickly running out. For the majority of EU countries, debt is now rising faster than GDP. From the standpoint of many investors, default seems like the most likely outcome since such countries lack the political muster to reduce their budget deficits, nor can they devalue their debt through currency depreciation, due to the common currency.

Thus, the consensus (for now) is that the Euro’s run will soon come to an end. According to Citigroup, “The euro will resume its decline and head toward the $1.10-$1.15 range. ‘The market has digested a lot of the bad news about the euro. There’s no great optimism.’ ” Meanwhile, BNP Paribas “expects the euro to fall to parity by the end of 2010—one euro per dollar—a level it hasn’t seen since December 2002…[and] drift to 97 cents before hitting bottom in the third quarter of 2011.”

Post Details
Posted on July 18, 2010
at 10:44 am
Written / posted by: Simon
Filed under: Currency Trading, Sharp Observations, forex trading

In October, I wrote about a “separation” that had taken place in currency markets between the “sick” currencies and the “healthy” currencies. At the time, I argued that the former category was comprised mainly of the Dollar and the Pound, with most other currencies healthy by comparison. While I still stand by this paradigm, I would like to revise it slightly. Specifically, I would like to add the Euro and the Yen to this list.

The recent blow-up surrounding the downgrade of Greece’s debt and subsequent explosion in the price of credit default swaps (which insure against default), have shined a spotlight on the fiscal problems of many of the EU’s member states, including Spain, Italy, Portugal, Ireland, and others. The situation in Japan, meanwhile, has been much more gradual, though equally dangerous: “In 1990, Japan’s total national debt load was 390% of GDP. Now it’s 460%. In the interim, the country has suffered sub-par growth and routine recessions.”

The fiscal problems of the US and UK governments as well as the debts of their citizens and companies have long been famous. For that reason, when the sick/healthy paradigm was first proposed, they were the two most obvious candidates. Having conducted some additional analysis, it’s now patently obvious that the same problems affect the EU and Japan. Given that their economies are also in weak shape, it doesn’t really make sense to group them in with the healthy currencies. Canada (and the Loonie, by extension) is also looking sickly, with its surging national debt and record budget deficits. The only reason it is being spared from the list is because of its richness in natural resources; in other words, it has something tangible that it can use to pay its debts.

Among the so-called majors, then, only the Swiss Franc, Canadian Loonie, Australian Dollar, and New Zealand Dollar get clean bills of health. A re-casting of the paradigm, then, would put the super-majors (Euro, Yen, Pound, and Dollar account for more than 75% of all foreign exchange activity) on one side, and virtually every other currency on the other. Given that national debt ratios and interest rate differentials diverge across the same boundary, it’s not hard to conjure a basis for this partition. “The IMF forecasts that gross government debt among advanced economies will continue to rise until 2014, reaching 114% of GDP, compared to just 35% for developing nations.” Adds another analyst: “If you look at currencies as a proxy for growth, then you can anticipate that emerging-market currencies will appreciate against the dollar.”

P135_G20
There is also a correction that is taking place within the group of sick currencies. Investors have come to realize belatedly that a Dollar sell-off doesn’t make any sense against the Euro and Yen, whose economic and fiscal situations could hardly be characterized as healthy. “Against the majors, we’re pretty close to the end, if we haven’t already reached the end of a bear market in the dollar,” asserted one analyst. Given that the Dollar’s demise had all but been taken for granted, this reconsideration isn’t coming natural. Volatility has surged to a 3-month high, and investors are responding by moving funds back to the US. Among the majors, then, it looks like the Dollar is still the “least worst” currency.

Post Details
Posted on January 30, 2010
at 7:03 pm
Written / posted by: Simon
Filed under: News, Sharp Observations, forex trading

President Barack Obama trumpeted his message of change all the way to the White House, but when it comes to the U.S. tone on China and its yuan, economists say that message might not apply. U.S. manufacturers have long claimed that the Chinese currency is undervalued, giving its goods a competitive edge. A weaker currency helps exporters by making their goods more attractively priced in overseas markets, and boosting the value of their repatriated profits. While Bush administration officials sometimes called for greater yuan appreciation, their pressure was relatively light. “As Treasury Secretary, [Henry] Paulson has favored the buddy-vs.-bully approach to China. Although the Chinese yuan has appreciated 15% over the past two years, it is still considered undervalued,” said Kathy Lien, director of currency research at GFT in New York.

In the first half of 2008, the Chinese currency appreciated about 6% against the U.S. dollar, but it was largely flat in the second half. Some investors are fearful that the new administration will step up the pressure on China to allow its currency to strengthen further, and that this will lead to deteriorating trade relations between the two countries.

Whether the Obama administration will change the U.S. tone on China “is a matter of concern. I do believe that the new administration may take a more protectionist approach, which may include pushing for a more favorable currency position,” said Rob Lutts, the chief investment officer of Cabot Money Management, a Salem, Mass.-based independent wealth-management firm. “There is a real danger in this new administration that they may abandon the free-market approach that we have all become reliant on in our analysis. We may find an administration that becomes tough on trade and sets barriers to global trade,” he added.During the campaign, Obama focused his attention elsewhere. But his Democratic rival Hilary Rodham Clinton the incoming secretary of state sometimes took aim at China’s trade surplus and product-safety record. Some politicians have even warned that Obama could not only step up the rhetoric, but back up tougher words with action. “I don’t think just jawboning will be the approach of this administration,” Rep. Sander Levin, a Michigan Democrat who chairs a trade subcommittee in the House of Representatives, said Wednesday, according to media reports.

Domestic priorities
In fact, China itself has every reason to avoid both depreciation and appreciation of its currency. The latter could further weigh on already drooping exports, and the former could lead to capital outflows from the country, at a time it can least afford this. Chinese authorities, like their U.S. counterparts, are giving priority to domestic economic challenges, as their country’s economic growth slows. Gross domestic product eased to 9% on the year in the third quarter of 2008, after growing by 11.9% in 2007. Reflecting the weak global demand, China’s exports contracted in December at their fastest pace in almost a decade. Shipments fell 2.8% to $111.16 billion from a year earlier, their biggest contraction since April 1999. See full story on China’s export slowdown. But so far, China does not appear to be poised to export its way out of the global downturn. Instead, it is pinning its recovery hopes on stimulus and steps aimed at boosting domestic demand, which bodes well for those betting on stable foreign exchange.

China has committed $586 billion in stimulus spending during the next two years to offset the effects of the global slowdown, with the bulk of the outlays expected to go toward infrastructure projects.
The People’s Bank of China has cut interest rates five times and reduced banks’ reserve requirements three times, since it embarked on a monetary-easing cycle in September in response to the deepening global economic crisis.
“While pressure is rising from slowing exports and GDP growth, we believe China will opt for exchange-rate stability in the near term,” said Stephen Schwartz and Ting Lu, Hong Kong-based analysts at Merrill Lynch.
“The authorities’ response to slowing growth has been an aggressive easing of fiscal and monetary policies to stimulate domestic demand, consistent with their stated longer-term goal of rebalancing growth toward domestic consumption and away from external demand,” they wrote in a research note.

Manipulator, or not
Last month, the outgoing Bush administration passed up its last chance to label China as a currency manipulator.
In its biannual report to Congress on the foreign-exchange market, the Treasury said that no major trading partner, including China, met the standards to be labeled a manipulator. “There is some speculation that Obama will reverse this and cite China, which would open the door to possible retaliation” if subsequent negotiations were to fail, according to Marc Chandler, global head of currency strategy at Brown Brothers Harriman & Co. in New York.. “But there is little basis to believe this talk has merit.”
He said that Obama’s picks for the Treasury Department are heavily weighted in the free-trade wing of the Democratic Party. Therefore, Chandler added, Obama’s team — as well as the media — should “focus on the broad relationship with China and not allow the bilateral nominal-currency relationship to dominate his message.”

Post Details
Posted on January 22, 2009
at 10:02 pm
Written / posted by: Piere
Filed under: Currency Trading, News, Sharp Observations, forex trading

As 2008 comes to a violent end, forex analysts are releasing their predictions for 2009. Most believe that risk aversion and interest rate discrepancies will cease to weigh on forex markets, especially compared to 2008, when investors unwound carry trades and parked their money in low-yielding (but apparently less risky) US and Japanese securities. Instead, investors will probably begin to focus more on economic fundamentals. With regard to the Dollar, this approach could work either way. On the one hand, it is conceivable that the US will outperform (this could translate into a milder recession) the EU and Japan, since the Fed’s interest rate cuts were implemented at such an early stage. On the other hand, the US twin deficits continue to expand, which suggests the possibility of long-term inflation as well as a potential reluctance in foreigners to continue to lend to the US.

Marketwatch reports:
To be sure, the dollar’s 2009 trajectory depends a lot on what the U.S. and global economies do, and when they do it. The U.S. recovery could begin midyear, or the clouds could linger until the fourth quarter or even longer.

Post Details
Posted on December 30, 2008
at 1:12 pm
Written / posted by: Simon
Filed under: Currency Trading, Sharp Observations, forex trading