Seven years in the making

Posted on November 23, 2015 8:16 pm by Greg

On the move

I thought I’d start this week with a friendlier Blog post rather than the AmpGFX report. It feels like I am up and running with a flagship report, hopefully you find it thought-provoking and useful for staying in touch with the FX market.

I had a few technical hiccups late last week that disrupted service. And I accompanied my younger son Josh on a tour with his team mates at Centaurs Rugby in Singapore to the Hong Kong Sandy Bay Rugby tournament over the weekend. We arrived back at home at around 2pm on Monday morning, and like Josh, I decided to sleep in and go to school late.

Josh has really enjoyed his Rugby in Singapore, and we will be on the hunt for a club to play with in Colorado.

The move to Breckenridge Colorado is getting very real for our family and while we are excited, we are also sad to be leaving our friends in Singapore.  Our bewildered boys have found their furniture sold and taken literally from underneath them and the movers are coming next week to pack up what’s left.

I can imagine AmpGFX reports will be quite a bit disrupted over December as we spend some time in Australia before heading to Breckenridge after Christmas.  But I will try to keep the ball rolling.  Perhaps I will use the blog posts more frequently and ramp AmpGFX back into full flight in January.

Over the last month or so in Singapore, I have been lucky enough to be invited to work out of the offices of Kit-Trading a new company that “incubates and supports talented trading groups or individuals.”

Kit is associated with Vulpes Investment Management and I am very grateful to the team at both companies that have provided a very supportive environment for me to break ground with my business.  They have an interesting model and I may well develop a lasting relationship with the group as I seek to evolve over time into managing capital.

My plans for Amplifying Global FX Capital are evolving, but I am keen to keep the flag ship report open to all willing readers for the next year, so please keep spreading the word if you like the report and forward my email alerts to your contacts in the market.

I am now actively trading my own capital, so you are getting a report from a unique perspective of an experienced FX strategist that starts with fundamentals and is highly focused on finding tactical trading opportunities and often has positions in the currencies I am writing about.

Will Glenn choke on his words?

You might have guessed if you were reading my reports that I experienced a bit of financial pain with the rally in the AUD late last week as it rallied despite an intensifying decline in commodity prices.

It will be interesting to see if RBA Governor Glenn Stevens has anything to say about the currency in light of recent further weakness in commodity prices.  The RBA has been drinking from a glass half-full in recent months seeing significant improvement in the services sector, benefiting from a weaker exchange rate.

The RBA’s confidence has been infectious driving out most of the rate cut expectations that were built into the market at the end of October.  And the AUD had a pop higher late last week as global risk appetite improved on the Fed’s assurances that rate rises would be very gradual.

However, in the to-and-fro of FX markets, the AUD dropped back on Monday as the fall in commodity prices intensified.  Nevertheless it remains higher than a week ago, still in a little rising trend over recent weeks, and it has been making higher lows since early-September.

On the exchange rate, the RBA has said recently only that “the Australian dollar was adjusting to the significant declines in key commodity prices.”  One must wonder now if RBA Governor Stevens still feels the same way about the currency ahead of what may be a key speech to the Australian Business Economists on Tuesday evening in Sydney.

Those same words might catch in his throat a bit if he tried to repeat them.  Perhaps he will add that more recently the AUD had not responded to fresh falls in commodity markets and the importance that it continues to remain low to support the economy.

That time of year

We are in that phase of the year where major investors and fund managers are reluctant to take new bets and tend to take risk off the table, eyeing the end of the year book closing and holiday season.  This can often add to the confusion over what are the key fundamental drivers making it hard to trade with conviction.

Examples in the last week might be the fall in the USD after the FOMC minutes and various Fed members reaffirmed an intention to raise rates on 16-Dec, barring significant surprises.

The potential upside for the USD may be limited because the market is now ready for the Fed to hike, so it is prone to a squeeze of long USD positions as we move into year end.

Indeed some voices in the market are calling for a peak in the USD on the idea that it has already factored in a phase of policy tightening and now appears relatively expensive.

The EUR was also trying to rally last week in the face of generally dovish comments from ECB board members.  However a decisive statement of intent by ECB President Draghi put to rest a modest recovery in EUR on Friday; at least for the moment.

Investing and trading are a matter of weighing the various probabilities against what is priced into the market.  It is possible that the USD could weaken even as the Fed implements its first policy tightening on 16-Dec, if the market believes that the pace of tightening beyond that will be halting and cut short.

It is possible that the EUR might rally from current levels if the market believes that the ECB’s next policy easing will be the last and the recovery in the European economy is sufficiently strong to countenance the idea that the ECB could end its QE sub-zero rates policy sooner.

It is true that the differences between the US and European economic growth and inflation outlooks have probably narrowed in recent months, even though the central banks in the two regions appear to be diverging more.  If we were to look only at the recent data trends and inflation expectations data we might conclude that a low in the EUR is not too far away.

Such discussions might open up debate across the table at investment committees over whether it is time to start shifting currency exposure back to EUR.  In the context of an approaching year end, and a desire to lower overall risk and move closer to benchmark, some investors may simply see this as the prudent step as the broad-turning point exchange rate cycles may seem more uncertain.

Hankering for a semblance of normalcy

However, while there may be reason to doubt Draghi’s case for aggressive further easing and the Fed’s case for choosing this moment to begin its policy tightening, there has been a degree of hardening in the divide of these two key central banks, suggesting it is still too early to presume the low is in for the EUR.  Indeed tactically it continues to make sense to stay the course on short EUR strategies even as the market gets nervous that the bottom is approaching.

Many central banks, governments, and influencers globally believe it is time to see how the world responds to raising US rates off their near zero target.  This is not so much about the US economy suddenly picking up momentum, it is about a sustained period of recovery over the last several years, albeit less strong than previous cycles, and a desire to ween global markets off medicine that may starting to do more harm than good.

There are cautionary voices that higher levels of emerging market leverage and low levels of global inflation make this too dangerous, but the gut feel of most key influencers is that the patient is ready to try and breathe without life support.

There was a perceptive groan of dismay across the world when the Fed kept rates down in September, even from emerging markets that might have the most to lose from higher US rates; the initial market reaction at the time was a further global markets sell-off.  There was no relief-rally when the Fed kept rates low, suggesting that the market can see harm if US rate hikes always seem out-of-reach. Investors hanker for a semblance of normalcy from the world’s leading economy and guardian of the main reserve currency and linchpin of global finance.

Even though the pace of the US recovery has slowed this year, and inflation expectations have ebbed with lower commodity prices, there has been enough evidence to suggest the recovery is resilient enough in the face of tightening financial conditions to withstand some hike in interest rates.  The Fed has led the market to believe this is possible with painstaking gradual guidance and the market is on-board.

The implication for the USD has already been positive, and some may argue it is all priced in.  But the important element here is that there has been a bigger structural shift in Fed thinking that will not be easily reversed.  It has moved out of an emergency policy setting frame of mind.  It sees the US economy as capable of sustaining full employment and, given enough time, for inflation to normalize.

It has cajoled the market into believing any rate moves from here will be delivered gradually to ensure a sustained recovery and shore up confidence.  But the key message is that policy is on a tightening trajectory that is unlikely to be reversed.  It may pause from time to time, but it is unlikely to turn back. This trajectory should support a rising USD trend for a while yet, especially when you consider the alternatives.

Driving home the advantage

The ECB message is polar opposite. The Eurozone has endured a near death experience in 2010/12. It has experienced a long drawn-out painful period of under-employment and retrenchment in private sector debt and bank balance sheets.  Its governments’ have been in upheaval from social unrest, and now it is coping with a refugee crisis and heightened terrorist threat.

The central bank under Draghi is not taking any risk that hard fought gains in economic confidence and banking sector recovery will be for naught.  He is intent on driving home the advantage, be damned the conservative voices from the Bundesbank still haunted by the hyper-inflation era pre-WWII.  He is not put-off by a modest recent fall in EUR, and will not pull sail if as he hopes the recovery gathers momentum next year.

To buy the EUR now would be to give the market far too much credit for looking ahead to a time when the ECB may reverse its policy easing.  And a key point remains that ECB policy is aimed squarely at a weaker exchange rate.  This is not the old guard at the ECB influenced by desire to be like the Bundesbank and wear a strong exchange rate like a badge of honour.  No - negative interest rates, set to be driven deeper below zero, serve one main purpose -  to drive down the most interest rate sensitive financial market price – the EUR exchange rate.

Seven years in the making

A key point in setting strategy for the currency investing for the time-being is - do not get hung up on the idea that growth and inflation in the US and Europe are converging a bit, central bank policy direction is diverging because of factors that have been five to seven years in the making, EUR needs to be more than just cheap, it needs to be unequivocally and persistently cheap before the turning point comes into view, in my assessment.  EUR only got into a moderately weak zone early this year.