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July 2013
Volume 10, No. 7
Strategies, analysis, and news for FX traders
TAKING STOCK OF THE DOLLAR/YEN CORRECTION P. 18
The dollar in the
catbird seat? p. 6
Minor currenciesand the
LIBOR kerfufe p. 26
Market turning points
and overreactions p. 1
Gauging the qualityof your
trading system p. 20
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CONTENTS
Contributors................................................. 4
Global Markets
Dollar bull back into gear,
courtesy of the Fed .....................................6After a spring setback, the U.S. dollar appears
to have the wind at its back, thanks in large part
to one word tapering.
By Currency Trader Staff
On the Money
Overshooting the tipping points ............12
The Fed knew ending quantitative easing would
prick various market bubbles, but it seems to
have underestimated the extent and speed of
the reaction.
By Barbara Rockefeller
Spot Check
Dollar/yen.................................................. 18
History would argue favoring the short side in
the dollar/yen pair, but the recent correction
could be a pullback opportunity for longs.
By Currency Trader Staff
Trading Strategies
Measuring system quality
with Ideal R .............................................20
Calculating regressions on rolling time periods
of an equity curve provides a more accurate
understanding of a trading systems value.
ByDaniel Fernandez
Advanced ConceptsMinor currencies less affected by
great LIBOR kerfufe............................... 26
Why minor currencies were ahead
of their time and didnt know it.
By Howard L. Simons
Global Economic Calendar ........................32
Important dates for currency traders.
Events .......................................................32
Conferences, seminars, and other events.
Currency Futures Snapshot.................33
BarclayHedge Rankings........................33
Top-ranked managed money programs.
International Markets............................ 34
Numbers from the global forex, stock, and
interest-rate markets.
Looking for an
advertiser?Click on the company
name for a direct link to the
ad in this months issue.
Ablesys
eSignal
FXCM
Ninja Trader
Trade Tech FX
Questions or comments?Submit editorial queries or comments to
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CONTRIBUTORS
4 July2013CURRENCY TRADER
Editor-in-chief: Mark Etzkorn
Managing editor: Molly Goad
Contributing editor:
Howard Simons
Contributing writers:
Barbara Rockefeller,
Marc Chandler, Chris Peters
Editorial assistant and
webmaster: Kesha Green
President: Phil Dorman
Publisher, ad sales:
Bob Dorman
Classied ad sales: Mark Seger
Volume 10, Issue 7. Currency Traderis published monthly by TechInfo,Inc., PO Box 487, Lake Zurich, Illinois 60047. Copyright 2013 TechInfo,Inc. All rights reserved. Information in this publication may not be stored orreproduced in any form without written permission from the publisher.
The information in Currency Tradermagazine is intended for educationalpurposes only. It is not meant to recommend, promote or in any way implythe effectiveness of any trading sys tem, strategy or approach. Traders areadvised to do their own research and testing to determine the validity of atrading idea. Trading and investing carry a high level of risk. Past perfor-mance does not guarantee future results.
For all subscriber services:www.currencytradermag.com
A publication of Active Trader
CONTRIBUTORS
qHoward Simons is president of Rose-wood Trading Inc. and a strategist for Bianco
Research. He writes and speaks frequentlyon a wide range of economic and nancial
market issues.
qBarbara Rockefeller(www.rts-forex.com) is an
international economist with a focus on foreign exchange.She has worked as a forecaster, trader, and consultant at
Citibank and other nancial institutions, and currentlypublishes two daily reports on foreign exchange. Rockefel-
ler is the author ofTechnical Analysis for Dummies, SecondEdition (Wiley, 2011), 24/7 Trading Around the Clock, Around
the World (John Wiley & Sons, 2000), The Global Trader(John Wiley & Sons, 2001), The Foreign Exchange Matrix
(Harriman House, 2013), and How to Invest Internationally,published in Japan in 1999. A book tentatively titled How
to Trade FX is in the works. Rockefeller is on the board ofdirectors of a large European hedge fund.
qDaniel Fernandezis an active trader
with a strong interest in calculus, statistics,and economics who has been focusing
on the analysis of forex trading strate-
gies, particularly algorithmic trading andthe mathematical evaluation of long-termsystem protability. For the past two years
he has published his research and opinions on his blogReviewing Everything Forex, which also includes re-
views of commercial and free trading systems and generalinterest articles on forex trading (http://mechanicalforex.
com). Fernandez is a graduate of the National Universityof Colombia, where he majored in chemistry, concentrating
in computational chemistry. He can be reached at [email protected].
mailto:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]://www.rts-forex.com/http://mechanicalforex.com/http://mechanicalforex.com/mailto:[email protected]:[email protected]:[email protected]:[email protected]://mechanicalforex.com/http://mechanicalforex.com/http://www.rts-forex.com/mailto:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected] -
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GLOBAL MARKETS
Despite a correction in late May and early June, the U.S.dollar (USD) was still up on the year vs. a variety of majorand emerging-market currencies at the beginning of July,and many analysts expect the overall appreciation trendto continue in the second half of 2013 (Figure 1). The dol-lar was little changed vs. the Euro (EUR), but scanninga range of global currencies shows the buck was much
more a winner than a loser in the first half of the year. Asof late June the U.S. dollar had gained nearly 13% vs. the
Japanese yen (JPY) and the Australian dollar (AUD), andmore than 5% vs. the Canadian dollar (CAD) and theBritish pound (GBP).
The U.S. Federal Reserves recent hints about the taper-ing of quantitative easing, or a reduction in the amount ofmonthly asset purchases it is currently making to stimulatethe U.S. economy, reinvigorated dollar bulls. Also, mod-
erate improvement in the U.S. economy could make thegreenback the least ugly in a currency beauty contest
among major industrialized economies.Lets first look at the immediate, and dramatic,
effects of the Federal Reserves recent commentsregarding tapering its asset-buying program.
The Fed speaks
When asked to pinpoint key U.S. dollar driversin the months to come, Alvise Marino, foreignexchange strategist at Credit Suisse, says the Fedis the main one. The Fed is turning tighter, while
other central banks are steady or turning easier,he says.
At its June 19 policy meeting, Fed officials stat-ed the downside risks to the economy had dimin-ished in recent months, and in Federal Reservechairman Ben Bernankes June 19 press confer-ence, he suggested if the current Fed economicprojections pan out, the asset purchases will con-clude by mid-2014.
The U.S. dollar rallied in the wake of the meet-ing as Fed officials indicated a cutback in theFeds current $85 billion per month of asset pur-
Dollar bull back into gear,courtesy of the Fed
After a spring setback, the U.S. dollar appears to have the wind at
its back, thanks in large part to one word tapering.
BY CURRENCY TRADER STAFF
FIGURE 1: RESURGENT DOLLAR
After a sharp May-June correction, the U.S. dollar turned higher
again on June 19 when the Fed discussed the eventual wind-down
of its quantitative easing program.
Source for all figures: TradeStation
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chases could come sooner than expected. While it is by nomeans a tightening of U.S. Federal Reserve policy, sucha tapering would mark the beginning of the end for theultra-loose approach to monetary policy in recent years.
Forecasts of when tapering might begin vary widely from the July 30-31 FOMC meeting to as late as Decemberand even into 2014 if economic conditions deteriorate
again. Markets will be finely tuned to labor market andinflation data, and will likely gyrate as tapering expecta-tions shift.
In a June 19 research note, Credit Suisse analysts wrotethey had been looking for the first cutback in the monthlyasset purchase pace in September, but after the Fedsannouncement they decided the July 30-31 FOMC meetingwas now a possibility, so long as labor market data do notdeteriorate and inflation expectations hold near their new,lower levels.
Bob Lynch, head of G-10 FX strategy Americas HSBC,notes that even though the Fed might not taper until the
end of the year, that doesnt mean the markets wont reactsooner. Even just the expectation that it is coming is hav-ing an impact on our markets, he says.
Economic improvement
Another factor that could support U.S. dollar bullishnessin the second half of the year is continuing improvementin the U.S. economy a prerequisite for the U.S. FederalReserve to begin reducing its monthly asset purchases.
Even amid the twin fiscal shocks of fiscal-cliff squab-bling and sequestration, the worlds biggest economyhas been surprisingly resilient, wrote Beth Ann Bovino,
deputy chief economist at Standard & Poors in a June 21research note. In the first quarter, consumers have spentat the fastest pace in two years. Additionally, the hous-ing market continues to improve, and although businessinvestment has slowed, managers are still hiring. Sheexpects Fed tapering to begin in December.
Recent U.S. jobs data has shown a stable labor market,
but not necessarily a strongly growing one. In May, non-farm payrolls rose by 175,000, following Aprils 149,000increase. The unemployment rate stood at 7.6% in May.The Fed has pointed to a 6.5% unemployment rate as a keythreshold for raising its benchmark lending rate, the Fedfunds rate. Thats a separate issue, however, from a taper-ing of the monthly asset purchases, which is expected tobegin well before a rate hike.
Despite some stumbles, such as the downward revisionof Q1 GDP on June 26, most analysts seem to think theeconomy is growing, if not briskly.
We do think the U.S. recovery is gaining traction, says
Jeet Dutta, senior economist at Moodys Analytics. So farthis year data has surprised on the upside. We expectedsequestration to take a heavier toll, although we still thinkthe worst could be ahead when we see the [government]furloughs. Overall, Moodys Analytics forecasts 2013 U.S.GDP around 2%.
Currently, though, Dutta says the private sector is strongenough to handle these fiscal blows. If this trend can holdup for a few more months, by year-end and into next year,things will look a whole lot better, he says. Dutta addsthat sequestration represented a roughly 1.5% hit on theeconomy this year and estimates if the federal government
Analyst estimates of when the tapering
process will begin range from as soon
as the July 30-31 FOMC meeting to as
late as 2014, if economic conditions
deteriorate again.
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GLOBAL MARKETS
had kept spending steady, GDP growth for 2013 would bearound 3.5%. Moodys is forecasting 2014 U.S. GDP at 3.5%and 2015 at 4%. In the meantime, Dutta thinks consumerswill do their part to fuel the economic flames.
Overall, many of the excesses of the Great Recessionare slowly healing, he says. A lot of consumers bal-ance sheets are [improved], and they are in better shape to
spend more. There is a lot of pent-up demand, especiallyfor autos, which will keep auto purchases at a healthypace for the next year, and there are many other categorieswhere consumers simply need to replace. Finally, housingwill be more and more of a positive factor.
The Fed, Dutta argues, is more or less correct in read-ing the latest numbers and concluding the recovery is onmore steady footing. It is proving more sturdy than mostpeople thought, he says.
In contrast, Jay Bryson, global economist at Wells Fargo,weighs in on a more cautionary note. We dont think theeconomy will go back into recession, but we dont look for
a big breakout, he says. We are still forecasting 2-2.5%over the next few quarters.According to Bryson, there are some persistent uncer-
tainties with the potential to hamstring growth. There isprobably still some deleveraging that needs to occur withconsumers, he says. House prices still havent recovered people dont feel as wealthy as they once did. There arestill some uncertainties for businesses, and the [long-term]fiscal situation is not settled by any stretch of the imagina-tion.
Treasury yields
Another dollar-supportive factor is rising U.S. Treasuryyields. Ten-year T-note yields had already been climbingsteadily since early May when they received a big boostfrom the Feds June 19 announcement. After being aslow as 1.61% as recently as early May, the 10-year yieldclimbed from 2.15% to 2.65% between June 19 and June25. The change corresponded into a sharp jump in 30-yearfixed mortgage rates as well.
In general, the rising yield environment is bullish for theU.S. dollar. The higher Treasury yields are helping theU.S. dollar as it attracts some inflow into the U.S., saysCharles St-Arnaud, foreign exchange strategist at Nomura.
Many U.S. investors saw opportunity in Mexico andBrazil. Now that yields are rising in the U.S., they are redo-ing their math and realizing those countries arent as gooda bet from a currency and bond perspective.
However, the rising yield environment has other rami-fications, including a potentially negative impact on thehousing market recovery. A sudden, sharp increase inlong-term rates could potentially discourage home buy-ers, Moodys Dutta notes.
The impact of higher rates wouldnt necessarily be lim-ited to housing prices, either. Weve seen a big back-up
in yields, he Wells Fargos Bryson says. If they continueto move north, that could be a restraining factor [for theeconomy]. His firm expects the U.S. Fed to wait untilDecember to begin tapering.
Fiscal improvement
The U.S. fiscal picture has been improving, if partially bydefault via the sequestration, or automatic spendingcuts that went into place in early 2013. Rising tax revenuesfrom the expiration of the payroll tax cut and other incometax increases have also helped reduce the deficit this year.
Of course, the U.S. still has a large deficit and there
remain long-term issues regarding unsustainable SocialSecurity and Medicare spending, but in the short term,the year-to-date deficit is below that for fiscal year 2012.According to Briefing.com, through May the federal bud-get deficit stood at $626.2 billion, or $218.2 billion less thanfiscal year 2012.
The fiscal backdrop in the U.S. has turned betterbecause of the sequester, says HSBCs Lynch. We stillhave a large deficit, but we are not adding to it at the pacewe had been. To the extent that it [previously] looked asif a continued weak fiscal backdrop could lead to anotherratings downgrade or a threat to the dollars reserve cur-
The U.S. fiscal picture has been
improving, partially by default
because of sequestration.
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rency status, that element seems less problematicfor the dollar.
So what dollar plays look most promising inthe second half of the year?
Currency action
Nomuras St-Arnaud says the dollars gains in
the first half of the year stem from a combinationof dollar-supportive factors and negative coun-try-specific stories.
The yen has new monetary and economicpolicies, which put pressure on the currency,he says. The Australian dollar has seen lowercommodity prices and a central bank that cutrates, and the Canadian dollar has seen economicunderperformance.
Kevin Chau, forex strategist at Ideaglobal,notes the dollar is currently in an enviable bull-ish position. I see the dollar being stronger in
the second half, he says. If the U.S. economyimproves, the dollar wins. If the economy doesntimprove, the dollar wins on safe-haven buying.
According to BNP Paribas forex strategistVassili Serebriakov, the commencement of taper-ing should be quite supportive of the dollar.We prefer to play it vs. other low-yieldingcurrencies, like the Japanese yen and the Swissfranc, he says. We want to be long the dollaragainst currencies with central banks that arelikely to have aggressive monetary policy (Japan)or where they are preventing their currency from
appreciating (Switzerland).Serebriakov adds that his firm likes the generalidea of North America (including the Canadiandollar and Mexican peso) outperforming the yenand Swiss franc. BNP Paribas has a fourth-quar-ter target at 108 for the dollar/yen pair (Figure 2)and $1.03 for dollar/Swiss (Figure 3).
Credit Suisse also forecasts U.S. dollar strengthand yen weakness ahead. We still have the viewthe strategy employed by the Bank of Japan willwork, Credit Suisses Marino says. They pos-sibly could turn more aggressive on the easing
FIGURE 3: DOLLAR/FRANC
The Swiss franc shackled by its central bank is another
candidate for a long-dollar play.
FIGURE 2: A YEN FOR A RALLY
Despite an already robust uptrend, some analysts expect the dollar
to continue to appreciate vs. the yen.
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GLOBAL MARKETS
side. The yen is most disadvantaged [among the majors].Credit Suisse has a 12-month target of 120 in dollar/yen.
Nonetheless, Serebriakov notes that currency marketswill be closely eyeing upcoming U.S. economic data, andthe dollar-bullish plays will need action by the FederalReserve to gain steam. The Fed does need to start taper-ing, he says. This could change if the [economic] num-bers start to change. There are certain elements of the storythat still have to play out.
The Euro
Marino says his Credit Suisse is fairly bullish on the dollaracross the board with the exception of the Euro (Figure4). The firm forecasts the Euro/dollar pair (EUR/USD) at1.3700 by year-end and 1.400 in 12 months. The Euro story,Marino notes, has more than just one theme.
Its a flow story, he says. Europe has a record currentaccount surplus. Also, the market has been very short theEuro the past three years. Now that the tail-risk isnt there
anymore, we are seeing reallocation back to theEuro there is a rebalancing occurring. We areseeing central bank reserve managers who werevery into Australia and Canada now piling backinto the Euro.
The Fed bump
For now, the U.S. dollar appears to have the windat its back, thanks to the U.S. Federal Reserve.Youve got the Fed dialing back on QE while
other central banks are taking measures that willhave the opposite impact on their currencies,HSBCs Lynch says. The Bank of Japan is easing,in May the ECB cut rates, the RBA cut rates, theReserve Bank of New Zealand is intervening tosupport the kiwi, and the Swiss National Bankhas said a floor for Euro/Swiss is still in place.We expect the dollar to do better in the secondhalf.y
The dollars gains in the first half of
the year stem from a combination of
dollar-supportive factors and negative
country-specific factors.
FIGURE 4: THE EURO EXCEPTION
Renewed flows into the long-battered Euro may make it one of the
tougher currencies for the dollar to gain against.
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Victoria Park Plaza, London
17th - 18th September 2013
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Markets overshoot at policy tipping points, and thatswhat the Fed announcement after the June 19 FOMCmeeting on turned out to be, despite the Feds insistencethat reducing quantitative easing is not a policy changebut rather just easing up on the gas pedal. The bond mar-ket doesnt buy the analogy and sees the Fed hitting thebrakes.
In the first few days after the policy meeting, the yieldon U.S. 10-year notes soared to 2.6% (more than 100 pointshigher than in early May), with yields on all sovereign
notes rising, too the UK, Germany, and peripheralEuropean countries. Stock markets fell. The ShanghaiComposite lost over 5% in a single day, with Chinese equi-ty losses compounded by a central bank-approved liquid-ity crunch. Emerging-market currencies continued to fallas previously yield-hungry carry-trade traders withdrew.The dollar index rallied strongly. Commodities tanked.Volatility in every asset class rose to abnormally high lev-els. As noted before, in times of distress, intermarket cor-relations re-emerge, even if only for a few days.
The question for the FX market is
whether this is an authentic turningpoint that will put the dollar on a sus-tainable long-term uptrend, or if itsjust a flash in the pan stemming fromtemporary insanity. We argue that itsan authentic turning point that willhave long-lasting effects on everymarket, including FX, but just becauseits a historic change doesnt necessar-ily imply anything specific about thefate of the dollar. Yes, so far the dollaris the beneficiary of rising rates, butthe rate differential is not the only dol-
lar determinant.
The Fed vs. the marketWe didnt really hear anything newfrom Federal Reserve chairman BenBernanke at his June 19 press confer-ence, but markets freaked out anyway.The response seems to have been asevere overreaction, with the 10-yearyield rising more than 100 points ina month (Figure 1) and the S&P 500breaking support to the downside in
just the first few days after the policy
On the Money
12 July2013CURRENCY TRADER
ON THE MONEY
Overshooting
the tipping pointThe Fed knew ending quantitative easing would prick various market bubbles, but
it seems to have underestimated the extent and speed of the reaction.
BY BARBARA ROCKEFELLER
FIGURE 1: 10-YEAR YIELD INDEX VS. DOLLAR INDEX
The already rising 10-year T-note yield (black) leapt higher after Fed chairman
Ben Bernankes June 19 press conference, while the dollar (green) also turned up.
Source: Chart Metastock; data Reuters and eSignal
http://www.currencytradermag.com/index.php/c/Key_Conceptshttp://www.currencytradermag.com/index.php/c/Key_Conceptshttp://www.currencytradermag.com/index.php/c/Key_Concepts -
7/27/2019 Ctm 201307
13/36CURRENCY TRADERJuly2013 13
meeting (Figure 2). Its the size of the moves over such ashort period of time that makes them important.
The Fed was hoping futilely, as it turned out themarkets would accept the message in an orderly manner.After all, in May the Fed had given an early warning itwould start talking about tapering QE purchases. In thesix weeks between meetings, the markets were treated to afull analysis of the situation. In the end, the Fed deliveredwhat a plurality of analysts had expected (see The viewfrom the Fed, p. 16). It all seems reasonable and accept-able, especially if we adopt the Feds
new forecasts for the economy.Therein lies the rub. Many forecast-ers do not accept the Feds data fore-casts, claiming the Fed consistentlyoverestimates. The Fed sees growththis year at 2.3% to 2.6%, while privateforecasters have an average of 2.3%,the low end of the Fed range. Youcould argue if the Fed has overesti-mated, it wont begin tapering becauseit wont have the data to back it up,so whats the problem? The answerseems to lie in traders not trusting
the Fed to back off tapering even ifsub-forecast data starts coming in.Another problem is the Fed is will-ing to accept the participation rate,a key context for evaluating unem-ployment data, is now permanentlylower, allowing focus on the joblessrate alone. This smacks of rigging thenumbers. Finally, the Fed didnt offerany magic phrases, like green shootsor Bernankes more recent escapevelocity. The failure to create a catchyphrase at the June meeting is a short-
coming traders love magic phrases.Its hard to tell how much of the markets hysterical over-
reaction to tapering QE was inevitable because its seenas a historic event, and how much may be due to distrustof the Fed. Its never a good thing when markets broadlydemonstrate lack of trust in a central bank. The Bank forInternational Settlements (BIS), the Switzerland-based cen-tral bankers bank, issued its annual report the weekendafter the June FOMC meeting and ran to the Feds defense.The report says in no uncertain terms its time for central
Although the stock and bond markets
are throwing a tantrum and need to get
over it, central banks have no equivalent
of the parental time-out for traders.
FIGURE 2: S&P INDEX
The S&P 500 broke downside support in the first few days after the Fed June
policy meeting.
Source: Chart Metastock; data Reuters and eSignal
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14/3614 July2013CURRENCY TRADER
ON THE MONEY
banks to turn off the free-money spigot. Extraordinaryaccommodation gets the blame for delaying private sectordeleveraging and for making countries vulnerable to ris-ing interest rates, which, without an equal increase in theoutput growth rate will further undermine fiscal sustain-ability. The BIS says the global economy is past the crisisand the central bank job now is to return still-sluggisheconomies to strong and sustainable growth Alas, cen-tral banks cannot do more without compounding the risks
they have already created. To offer more extraordinarystimulus now would be increasingly perilous.
Inevitable destabilizationAlthough it appears the stock and bond markets arethrowing a tantrum and need to get over it, central bankshave no equivalent of a time-out for traders as parents dofor unruly children. And in practice, there was no betterway for the Fed to communicate that QE is ending. Inother words, traders were always going to freak out andthe Fed always knew it it just failed to judge the extentand pace of the reaction.
This is because of something that has been around fordecades in economic and central bank circles, the zero-bound problem: How does a central bank manage interestrates when the single rate it sets, in this case the Fed fundsrate, is at or near zero? The zero-bound problem is notthe same thing as Keynes liquidity trap, but its a kissingcousin. It seems there are two solutions to boost householdand business activity create inflation or change the fiscallandscape. The only policy a central bank can adopt, sincelegislatures control fiscal policy, is to create inflation. Notethat when Japanese Prime Minister Shinzo Abe announcedhis three-point plan to lift Japan out of recession, the firstpoint was to raise inflation to 2%. This was Bernankes
advice to Japan long before he became Fed chief.But QE didnt actually create inflation in the U.S., andso far its unclear how the Fed plans to promote inflationwithout QE. To a certain extent, the absence of any real
discussion of inflation is fishy. After all, Bernankes viewson the zero-bound problem are well known he wroteseveral papers and a book about it. Professional econo-mists are separated into two camps over QE those whosee the justification for boosting growth (Keynesians) andthose who oppose QE (Friedmanites). Only a few havewritten about what happens when stimulus is reduced orwithdrawn. These academic papers, some of them by Fedeconomists, are surely familiar to Bernanke.
The ending-QE analysis follows a familiar coursebecause government interference in markets always resultsin a misallocation of resources due to artificial pricing.Removal of that interference is equivalent to eliminatinga subsidy it changes the supply and demand metricsin one fell swoop, and permanently, having first distortedmarkets in a big way. And everyone acknowledges QE is,in essence, government interference in the biggest marketin the world after foreign exchange. QE affected not onlyits direct target, U.S. Treasury debt (and then mortgage-backed securities), but also every other security and asseton the planet.
It was always known QE would promote bubbles. Byartificially lowering the price of bonds through large pur-chases, the government feeds demand for higher-yieldingpaper in other sectors, including corporate and foreignbonds, but also equities and commodities. And by flood-ing the market with cash, the government risks promotinginflation. So far, inflation is not occurring because at thesame time QE went into effect, lenders tightened creditstandards and the Great Recession reduced demand forcredit, due in part to bankruptcies and foreclosures. Also,QE failed to cause the dollar to depreciate, as Keynesiansalways enjoy pointing out. Its true the dollar index low of71.58 was in March 2008 and its subsequent high of 88.49
was after the first round of QE in February 2009, but QEwas not the only FX-determinative event going on at thetime there was also the European sovereign debt crisis,the U.S. fiscal crisis and ratings agency downgrade, etc. QEmay not have caused the dollar to depreciate, but it almostcertainly contributed to the index dropping like a rock onQE announcements and staying low since 2009.
Reducing QE is not the same thing as ending it, but thebond market is acting as though it is. This is exactly thesame kind of reaction that economist Rudi Dornbuschproposed caused overshooting in the FX market in 1976.Overshooting works like this: Investors expect inflationto be much higher in the future, and thus anticipate tak-
Central banks refuse to take
responsibility for the bubbles they
created by interfering in markets.
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ing capital losses on bond holdings, so they demandextra yield today to make up for what they expect later.Commodities follow the same storyline those expectinginflation to follow from QE sought a form of protection inhard assets like gold. But with QE ending (and no actualinflation to be seen anywhere), the cost of inflation insur-ance is going higher, hollowing out the demand for com-modities.
For the FX market, the analysis is easy. The nominal
return became very low, below 0.5% for shorter maturitieslike the two-year note and as low as 1.60% for the 10-yearnote, pushing investors into higher-yielding currencies.The capital flows to high-yielding emerging marketsbecame so big several countries, most prominently Brazil,applied various forms of capital controls and complainedabout currency wars that raised their currencies toohigh, damaging exports. QE was, from day one, a policythat would depreciate the dollar, something acknowledgedby the Fed but as an unintended consequence. Dollardepreciation, however limited, gets the blame for furthercontributing to bubbles in foreign stocks and bonds as wellas commodities. We can blame dollar depreciation for con-tributing to the commodity price bubble, not only becauseof the (so far) mythical inflation effect, but also authenticdemand because commodities are cheaper in local cur-rency terms.
Therefore, ending QE should raise the U.S. dollar, burstbubbles in the U.S. and foreign stock and bond markets,and burst the commodity bubble hardest of all. We areonly a few days into this new overshooting process, butalready some analysts are wondering whether the Fed willback down once it sees that its not only the central bank ofthe U.S., but of the world. And consider that in the absenceof inflation, falling asset prices are inherently contraction-
ary. Savers who desperately sought higher yields, includ-ing foreign yields, are going to take a big hit. In the U.S.,these savers are the very households on which the Fedis depending to pull the U.S. economy out of recession.Some institutions that specialized in this segment may fail.Maybe the financial sector will see a domino effect andmaybe the economy wont recover, after all.
In the end, QE removed or masked a proper respectfor risk, and ending QE reminds us this is how the wholething got started in the first place lack of respect formortgage credit risk. Traders used to joke about theGreenspan put, meaning former Fed chairman AlanGreenspan was attentive to stock market declines and
could be counted on to loosen policy in the face of a sharpdrop. Now we have the equivalent of a Bernanke sub-sidy that is suddenly being withdrawn. Never mind thatits not sudden and not a full withdrawal, just talk aboutwithdrawal, but investors and traders are acting like pen-sioners who just got a 40% cut in their monthly check.From their point of view, this is an accurate description oftheir wealth and income prospects.
From a broader and more political perspective, QE sup-ported banks and brokers and their clients, whether theyhave yachts or not. We normally think of government sub-sidies as supporting persons and households, or at leastworthy sectors (agriculture), not the financial elite andtheir institutions. This is not strictly accurate (consider themilitary-industrial complex), but never mind publicacknowledgement that QE was designed to save the bigshots has not gone unnoticed. Ostensibly the true targetof QE was to rebuild household demand, but with incomeinequality so high, its not clear QE resulted in sufficienttrickle down. In fact, all QE did was rescue the financialsector, or at least most of it, without fixing moral hazard atthe same time (too big to fail).
Central banks are more than reluctant to talk aboutbubbles they refuse to take responsibility for those theycreated by interfering in markets. Yes, the Fed undoubted-ly knew that ending QE would prick bubbles all over theplace, and yet it seems to have underestimated the extentand speed of the reaction.
Whats nextWeirdly, the FX market also knew from the May FOMCmeeting the Fed would announce tapering at the Junepolicy meeting, and yet by the week of June 18, FX specu-lators had already flipped from a net short Euro positionto a small net long, according to the CFTC Commitments
The longstanding pro-Euro bias is
asymmetrical a small amount
of favorable news has an outsized
effect while a big dose of bad news
is shrugged off.
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ON THE MONEY
of Traders Report. Speculators had a net long position of7,533 contracts, from a 20,030-contract net short positionthe week before. The largest net short Euro position (84,644contracts) since November 2012 was only a few weeks ear-lier. The CFTC releases its data every Tuesday, and the Fedpolicy meeting and announcement was the very next day,Wednesday, June 19. In other words, those newly long Euroswrongly anticipated a dovish Fed and got slammed.
Dashed dovish expectations imply some press reports maybe right the Fed doesnt really intend to end QE rightaway (September) and is just preparing the ground. Afterall, the Fed never actually named the month tapering wouldbegin.
Can this be right? Well, yes, and for several reasons. First,the data may not come in as rosy as the Fed forecasts. Also,the Fed may start to make soothing noises about postponingthe start of tapering, specifically to try to repair market insta-bility which after all, is a Fed mandate. Behind the scenes,the Fed may be hoping to see a little inflation emerge, too.This may take the form of data that is not strictly inflationdata, such as wages and import prices.
And finally, something may be brewing elsewhere, suchas the European Union plan to capitalize newly distressedbanks directly with Emergency Stability Facility funds ratherthan through the sovereign governments (and thereby impos-ing unpalatable conditions). As we continue to see, the long-standing pro-Euro bias is asymmetrical a small amount offavorable news has an outsized effect while a big dose of badnews is shrugged off.
We are left with two seemingly contradictory conclusions.The tapering of QE is an event of historic proportions, but itmay be delayed to make it seem less historic. The Fed cantbe seen as a hostage to market sentiment, especially of thetantrum variety, but it cant be insensitive to real distressin markets that could spill over into institutional failuresor other catastrophes. It would not be surprising to hear ofmoral suasion, aka arm-twisting, at the private meetingsbetween Fed and big bank officials.
In the end, the data will rule, and its data that will con -vince markets that tapering is acceptable. You have to won-der what the Fed knows about upcoming data on employ-ment and inflation that the rest of us dont. If data surprisesand tapering becomes acceptable, bond yields will fall. Andwe should assume that absent a European crisis, the dollar
will too.y
Barbara Rockefeller (www.rts-forex.com) is an international economist
with a focus on foreign exchange, and the author of the new book The
Foreign Exchange Matrix (Harriman House). For more information
on the author, see p. 4.
The view from the Fed
Key statements from the June FOMC meeting:Whentheeconomyisdemonstratingsustainablegrowth in employment, the Fed will buy lesser amountsof Treasuries and mortgage-backed securities (MBS)thanthe$85billionpermonthitstartedbuyinginSeptember 2012.TheFOMChasnotmadeapolicydecisionyet,but has come to a consensus it should start nailingdown details, including the amount by which to reduce
purchases and the date on which to begin (possiblySeptember).TheFedwillstopbuyingTreasuriesandMBSbytheend of June 2014 again, assuming the economicdata supports the tapering.IftheFediswrongaboutunemploymentfallingorother aspects of the growth scenario, it will stop taper-ing and increase purchases to higher levels. We dontknowif$85billionpermonthisacap.Reducingpurchasesisnotapolicychange.Itsthesame accommodative policy we had all along, just withless pressure on the gas pedal.Reducingpurchasesisnotraisingrates.TheFedfunds rate, the only rate actually set by the Fed, will
remainthesame(0to0.25%)until2015attheearli -est, and when the Fed does decide to raise rates, it willgive plenty of advance warning.
Federal Reserve Economic Forecasts:Inflationisstillabnormallylowbutwiththeexceptionof one dissenter on the FOMC board, rising inflationis not currently considered an issue. The PersonalConsumptionExpenditurespriceindexroseonly0.7%year-over-yearinApril,thelowestsinceOctober2009andmorethan1%underthe2%target.TheFedfore -caststhePCEindexwillriseto0.8-1.2%in2013(from1.3-1.7%forecastedinMarch)and1.4-2%in2014
(from1.5-2.0%forecastedinMarch).By2015,itwillbe1.6-2%(from1.7-2.0%forecastedinMarch).TheFedsjoblessrateforecastis7.2-7.3%thisyear(from7.3-7.5%intheMarchforecast),fallingto6.5-6.8%in2014(from6.7-7%intheMarchforecast)and5.8-6.2%bytheendof2015(from6-6.5%intheMarchforecast).U.S.GDPisnowforecasttogrow2.3-2.6%thisyear(from2.3-2.8%intheMarchforecast).Itwillgrow3-3.5%in2014(from2.9-3.4%intheMarchforecast),and2.9-3.6%in2015(from2.9-3.7%intheMarchfore -cast).
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ESE RESULTS ARE BASED ON SIMULATED OR HYPOTHETICAL PERFORMANCE RESULTS THAT HAVE CERTAIN INHERENT LIMITATIONS. UNLIKE THE RESULTS SHOWN IN AN ACTUAL PER-
RMANCE RECORD, THESE RESULTS DO NOT REPRESENT ACTUAL TRADING. ALSO, BECAUSE THESE TRADES HAVE NOT ACTUALLY BEEN EXECUTED, THESE RESULTS MAY HAVE UNDER-ORER-COMPENSATED FOR THE IMPACT, IF ANY, OF CERTAIN MARKET FACTORS, SUCH AS LACK OF LIQUIDITY. SIMULATED OR HYPOTHETICAL TRADING PROGRAMS IN GENERAL ARE ALSOBJECT TO THE FACT THAT THEY ARE DESIGNED WITH THE BENEFIT OF HINDSIGHT. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS L IKELY TO ACHIEVE PROFITS ORSSES SIMILAR TO THESE BEING SHOWN. THE TESTIMONIAL MAY NOT BE REPRESENTATIVE OF THE EXPERIENCE OF OTHER CLIENTS AND THE TESTIMONIAL IS NO GUARANTEE OF FUTURERFORMANCE OR SUCCESS. TECHNICAL ANALYSIS OF STOCKS & COMMODITIES LOGO AND AWARD ARE TRADEMARKS OF TECHNICAL ANALYSIS, INC.
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Dollar/yen
Long-term history would argue favoring the short side in the dollar/yen pair,
but the recent correction could be a pullback opportunity for longs.
BY CURRENCY TRADER STAFF
Into mid-year, the weakened Japanese yen
remained the lead story in the forex world. From
late May to mid-June the U.S. dollar/Japanese
yen (USD/JPY) made the first significant correc-tion of its approximately nine-month rally, fall-
ing from 103.73 to 93.78 (9.6%) before bouncing
back above 99.30 by the last trading day of June
(Figure 1). Still, the pair had already rallied some
35% off its mid-September 2012 low, so the pair
was still trading at relatively high levels as trad-
ing in July began.
Or was it? Figure 2 shows the current rally has
taken the dollar/yen to highs not seen since 2008
(and set the record for consecutive monthly high-
er highs, eight, through May), but its nonethelessjust one of several mostly minor counter-rallies in
the pairs generational downtrend. Its the biggest
rally since 2000-2002, but it hardly marks a sea
change in the dollar/yen relationship.
Where does that leave the pair in the days and
weeks to come? Those looking for market symme-
try will note the dollar/yens highs in April were
right around 100 the level the pair was trying
to reclaim as of June 28. Traders with a bearish
bent might see that price point as a short oppor-
tunity, although few analysts seem to believethe rally is done (see Dollar bull back into gear,
courtesy of the Fed). The Feds reminder on June
19 that quantitative easing will be downsized in
the not-too-distant future, and that it will increase
interest rates eventually (possibly in 2015), were
enough to knock the stock and bond markets for
a loop; it also gave a boost to the buck, which was
consolidating in mid-June after the correction. By
contrast, Japan has given no indication it intends
to rein in its easy-money policies.
SPOT CHECK
FIGURE 1: DAILY DOLLAR/YEN
After pulling back nearly 10%, the dollar/yen pair rebounded close
to 100 by June 28.
FIGURE 2: LONG-TERM VIEW
The dollar/yens current rally is its biggest in more than a decade,
but such moves have tended to be exceptions in a longer-term
downtrend.
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The highlighted bars in Figure 3s weekly chart
are a pattern that was identified (only) 42 previous
times in the floating-rate era: four lower weeklylows (concluding the week of June 14) followed
by a week with a close in the upper 40% of the
previous weeks range (the week ending June 21).
Figure 4 shows the average and median weekly
close-to-close changes after these patterns along
with the dollar/yens average and median changes
for all one- to four-week periods. Although the
post-pattern move is notably positive at week 1,
this bullishness quickly evaporates as the pairs
long-term bearish bias reasserts itself.
In the most recent pattern instance, week 1 cor-responds to the dollar/yens position as of the
June 28 close, at which point it had gained more
than 1.5% from the June 21 close. This does not
necessarily mean the pair is likely to sag in the
coming weeks. The vast majority of the pattern
instances occurred during longer-term down-
trends; the few instances that occurred in uptrend-
ing environments were mostly followed by sus-
tained (several weeks or even months) of gains.
The pattern tail will not walk the fundamental
dog here. Unless there is a fundamental reason
for the rally to have ended at this point (the dol-
lar/yens previous rallies have run approximately
18 months to three years), the correction must be
viewed as a pullback rather than the beginning
of a new significant downtrend. Nonetheless, the
brisk rally in the second half of June may make
waiting for a pullback (especially after a re-tag of
100) for long entries a wise course of action. Easing
pressure on the stock market will stem some of the
nervous-money flows into the dollar.y
FIGURE 3: WEEKLY DOLLAR/YEN
A pattern of four weeks of lower lows and a one-week rebound
concluded on June 21.
FIGURE 4: BOUNCE AND SAG
The pair tended to bounce back in the first week after the four-week
down-move pattern, but the markets long-term bias subsequently
weighed on price.
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All traders developing mechanical
strategies are eventually faced with
the problem of determining system
quality. This is commonly done to
know if modifications can improve a
certain strategy, or to choose between
different candidate systems for live
trading.
There are many statistical measures
designed to establish system quality,
including the Ulcer Index, maximum
drawdown, profit factor, Sharpe ratio,
etc., but all of them have significant
shortcomings that make them less
than ideal solutions. For example,
a strategy with a deep, short-lived
drawdown might have the same
Ulcer Index reading as a strategy with
a long, shallow drawdown, when
both strategies are, in reality, com-
pletely different.
Because of such limitations, traders
TRADING STRATEGIESTRADING STRATEGIES
Measuring system qualitywith Ideal R
Calculating regressions on rolling time periods of an equity curve provides
a more accurate understanding of a trading systems value.
BY DANIEL FERNANDEZ
FIGURE 1: MODELING PERFECTION
The perfect non-compounding system would exhibit a perfect linear relationship
between time and account balance.
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usually reference multiple statistical gauges to generate
a subjective vision of system quality because the relative
importance of the different variables is not formally estab-
lished. This creates problems in terms of systematically
evaluating strategy quality.
However, its possible to develop a set of statistics to
objectively compare different trading systems. We can do
this by establishing the nature of an ideal trading strategy
and then finding ways to measure deviations from this
behavior.
The ideal trading system
The first step, defining ideal trading results, is easy. A per-
fect non-compounding trading strategy would be a system
that exhibits a perfect linear relationship between time and
account balance that is, balance and time would be per-
fectly correlated, and the balance would increase as a func-
tion of time, without any losses, along a perfectly straight
line (Figure 1).
Once we know what the perfect trading system looks
like, we can start to evaluate how a trading system devi-
ates from this behavior.
Fitting the ideal system model
The most basic way to evaluate a strategys deviation
from the ideal system model would be to calculate a linear
regression of balance vs. time and determine how much
we deviate from a perfect fit to this model. This analysis is
easily conducted in Excel or any other statistical analysis
software by calculating a simple linear regression follow-
ing the form:
balance(time) = time*slope + intercept
Where balance is a function of time
Figure 2 shows this analysis carried out for two sample
systems.
FIGURE 2: STARTING WITH LINEAR REGRESSION
A linear regression of balance vs. time shows how much a systems performance
deviates from the ideal model.
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The most important aspect of this analysis is the Pearson
correlation coefficient (R) that allows us to measure the
goodness-of-fit to the linear model. An R of 1 implies a
very high positive correlation (closer to ideal), while lower
values imply lower system quality.
Although this criterion can help us distinguish between
overly good and bad strategies, it is certainly not the bestwe can do. Note that we cannot use the commonly used
correlation coefficient (R2) because the direction of a corre-
lation matters in trading; we are interested only in positive
linear correlations.
The problem with a simple linear regression is that in
trading we are concerned not just with the general correla-
tion of balance and time, but also about how the strategy
behaves within the curve. For example its not enough for
us to have an R of 0.99 because the equation that calculates
the R can generate high values for systems with periods of
high volatility (such as spike drawdowns).
Figure 3 shows a system with a 0.99 linear regression
coefficient, but it is obvious the system is not even close
to the ideal case because of the many spikes below and
around the linear regression line. The R calculation aver-
ages these profit and loss spikes, generating a problem in
terms of measuring system quality. Using this method, itbecomes increasingly difficult to tell which system is better
as we approach R values closer to 1.
This means we need a better model to assess system
quality one that goes beyond a simple linear regression
of balance vs. time.
Beyond simple global linear regression
Our challenge here is that we need to account for even
small deviations from linear behavior (i.e., from the ideal
system) to adequately determine how close a system is to
22 July2013CURRENCY TRADER
TRADING STRATEGIES
FIGURE 3: LIMITATIONS OF SIMPLE REGRESSION
Although this system has a 0.99 linear regression coefficient (R), its equity curve
is far from the ideal case.
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being ideal.
The way to do this is to divide the
balance curve into equally spaced time
periods and measure individual linear
regressions for each of them. Doing
this allows us to determine how linear-
ly the system behaved during shorter
time periods, which helps us avoid theR-value error-averaging problem in a
simple regression of the entire balance
curve. We can then calculate the aver-
age of the R values from all the smaller
periods to get a better statistical mea-
surement of system quality. We will
call this new statistic the average of
all sub-period R values the Ideal
R (IR).
Figure 4 shows the curves for two
systems that have been divided intoone-year periods, each of which have
been fitted with their own linear
regressions (blue lines). The simple lin-
ear regression analysis generated R val-
uesof 0.99 (System A) and 0.95 (System
B) for these two strategies, meaning
that both exhibit a large degree of cor-
relation between balance and time.
However we know these two strategies
look nothing like the ideal system in
FIGURE 4: R VS. IR
System A, which had an R value of 0.99, is revealed to have an IR value of only
0.47, while System B went from an R of 0.95 to an IR of 0.25.
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24/3624 October2010CURRENCY TRADER
TRADING STATEGIES
Figure 1 (the ideal system has no volatility whatsoever), soa more accurate system quality statistic should yield much
smaller values.
The IR values for the systems in Figure 4 provide a
much more realistic picture of their quality. The system
with an R value of 0.99 had an IR value of 0.47, while the
system with an R of 0.95 had an IR of 0.25. Not only have
we been able to get a much clearer picture of both systems
performance relative to the ideal (both are further away
from 1 than previously indicated), but weve also discov-
ered a much bigger quality difference between them. Now
we know System A (IR of 0.47) is much better than System
B (IR of 0.25), because it exhibits a much more positive lin-
ear behavior over smaller trading periods. Figure 5 shows
the variation of R along all the linear regressions carried
out across the different time intervals for both systems .
Limitations
Despite its apparent advantages, this technique is not
appropriate for all systems.
A system with a very low trading frequency will not
benefit from it (because its results will not be statistically
significant), while strategies with very high trading fre-quencies might require a much shorter divisions to deter-
mine the IR statistic and avoid the previously described
averaging pitfalls.
Linear regression, a very powerful tool
With the IR statistic you now have a very powerful tool
to measure system quality, which evaluates in a very clear
way how much your strategy deviates from purely ideal
behavior. Systems with higher IR values will be closer to
the ideal, perfectly linear growth model. Remember to use
non-compounding money management when evaluat-
ing this statistic and also make sure your strategy has a
large enough number of trades (at least 20 for each one of
the regression periods). An Igor Pro procedure script
including a function to calculate IR is also available for
download.yDaniel Fernandez is an active trader focusing on forex strategy
analysis, particularly algorithmic trading and the mathematical
evaluation of long-term system protability. For more information on
the author, see p. 4.
FIGURE 5: PERIOD-BY-PERIOD R VARIATION
R Values for the different periods are consistently better for the system with the highest IR.
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TRADING STRATEGIESADVANCED CONCEPTS
Does last months conclusion (see
Major currencies and the great
LIBOR kerfuffle) apply to a set
of minor currencies? The conclu-
sion of that article was:
No one knows when the era of zero
interest rates will end, how it will
end, and what the eventual market
structure will look like when it does.
What will remain constant, though,
is the inability of generalized and
simplified rules about what drives
currencies over time. Perhaps we
should be grateful: Just as a messy
election is the sign of a functioning
democracy, a messy market is one
people want to trade.
Minor currencies less affectedby great LIBOR kerfuffle
Why minor currencies were ahead of their time and didnt know it.
BY HOWARD L. SIMONS
The post-March 2008 period has some fairly distinct lines, which look as if they are
conveying signal and not noise.
FIGURE 1: MONEY-MARKET YIELD CURVESBEFORE AND AFTER BEAR STEARNS
0.8
0.9
1.0
1.1
1.2
1.3
1.4
1.5
1.6
1.7
1.8
1.9
2.0
2.1
2.2
2.3
2.4
2.5
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
ForwardRateRatios,Six-NineMonths
USD
CAD
EUR
GBP
AUD
SEK
CHF
JPY
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The approach taken for the majors was simple andstraightforward (or at least what passes for straightfor-
ward in these precincts). As purchasing power parity and
trade flows have proven well-nigh useless in assessing
currency movements over time, only two market-derived
variables hold out any hope for position traders: rela-
tive asset returns and expected interest rate differentials.
The total return for a countrys stock market relative to
the U.S. market, all expressed in USD terms, serves as a
proxy for relative asset returns. The difference in money-
market yield curves as measured by the difference inforward-rate ratios between six and nine months (FRR6,9)
between the non-USD currency and the USD is the dif-
ference in expected interest rates.
As before, the comparison will be split in time into the
periods before and after the Federal Reserve-orchestrated
rescue of Bear Stearns by J.P. Morgan Chase in March
2008. That preceded a story in The Wall Street Journal
one month later about reporting irregularities in LIBOR.
A cynic might note those irregularities were conducted
with the direct approval not only of the reporting banks
With the possible exception of the Taiwan dollar (TWD), these FRR6,9 lines suggest
we should lower our expectations that expected interest-rate differentials drive these
markets.
FIGURE 2: MONEY-MARKET YIELD CURVESBEFORE AND AFTER BEAR STEARNS
-1.0
-0.8
-0.6
-0.4
-0.2
0.0
0.2
0.4
0.6
0.8
1.0
1.2
1.4
1.6
1.8
2.0
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
ForwardRateRatios,Six-NineMonths
USD
ILS
INR
ZAR
TRY
THB
MXN
TWD
FIGURE 3: THREE-MONTH-AHEAD SPOT CURRENCYRETURNS, ISRAELI SHEKEL (ILS)
Pre-Bear Stearns takeover
Post-Bear Stearns takeover
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ON THE MONEY
28 July2013CURRENCY TRADER
ADVANCED CONCEPTS
in the British Bankers Association but of the regulatory
bodies involved: After all, no one wanted to report the
truth about the banks parlous state of finances and their
unwillingness to lend to each other.
Churchill said, In wartime, truth is so precious that
she should always be attended by a bodyguard of lies.
Of course, he was talking about matters of life, death, and
national survival, not of anything as crushingly important
as the basis for mortgage derivatives.
Messy markets
The messy markets referred to here and in last months
article have the advantage of producing neat charts
something more valued by the nations financial writers
than commonly admitted. Lets take, for comparison, the
map of FRR6,9 differentials for the major currencies shown
in Figure 1. The post-March 2008 period has some fairly
distinct lines and they look as if they are conveying signal
and not noise.
Now lets take the same construct for the set of minor
currencies to be examined (Figure 2). These are, with the
possible exception of the TWD, a random mess. It was dif-
ficult to select a set of currencies, as so many of the minor
currencies either lack sufficient length in their histories or
do not have nine-month interest markets. The very shape
and noisiness of the FRR6,9 lines in Figure 2 tell us we
should lower our expectations for expected interest-rate
differentials driving these markets.
As a reminder, we should expect a country whose
FRR6,9 starts steepening relative to the USD FRR6,9 to see
its currency rise relative to the USD, unless the non-USD
FRR6,9 is steepening bearishly and the prospect of higher
FIGURE 4: THREE-MONTH-AHEAD SPOT CURRENCYRETURNS, INDIAN RUPEE (INR)
Pre-Bear Stearns takeover
Post-Bear Stearns takeover
FIGURE 5: THREE-MONTH-AHEAD SPOT CURRENCYRETURNS, SOUTH AFRICAN RAND (ZAR)
Pre-Bear Stearns takeover
Post-Bear Stearns takeover
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short-term interest rates is leading a capital outflow out of
the country. Often, the currency already associated with
an already relatively steep FRR6,9 starts to weaken as the
short-term interest rates begin to roll down the curve as
nine-month rates become six-month rates, etc.
Another important point to consider is because most
investors are trend-followers and chase performance,
higher stock market returns relative to U.S. stock market
returns tend to lead capital inflows and push the currency
higher unless those inflows are forestalled by runaway
money-printing. As we saw in the Swiss case last month,
money-printing is a way of life in the modern world.
With these two preambles in mind, lets map three
month-ahead spot currency returns for the set of minor
currencies as a function of [FRR6,9Foreign - FRR6,9
USD] and
of the trailing relative stock market returns as measured
by the MSCI index return in USD terms between the non-
U.S. and U.S. markets. The maps for the Jan