Trend, Central Banks and Confusion
By John R. Taylor, Jr.
Ever since the Great Recession of 2008-2009, the foreign exchange markets have been buffeted by ever-increasing interference from government bodies, especially central banks, disrupting the day-today functioning of the market. In the old days, currency valuation was only one of the levers that governments had to move the market around. More important tools were money supply growth, interest rate levels, and fiscal policy. By changing the settings on these four instruments, overnments could control their economic growth, inflation and employment. The whole theory was conceived years ago by Jan Tinbergen, 1969 winner of the Nobel Prize for Economics. Currency was the step-sister of the other three, but in the aftermath of 2008, things changed as base money was growing through the roof, interest rates were at zero, and fiscal deficits were so high they could not be expanded. After the Greek crisis at the end of 2009 outlined the European problem (and everyone began to read the work of Hyman Minsky about debt instability), expansive fiscal policy became almost totally off limits. Then Bernanke’s August 2010 Jackson Hole speech ushered in the era of stuffing the economic goose with money, rendering monetary growth an unworkable variable, at least in its stimulative sense. With the impact of ‘tapering’ we can see that this variable still has teeth if governments are looking to slow the economy down, increase unemployment, and move closer to deflation, but of course, that is not what Tinbergen, Keynes and others saw as the value in these variables. So now, currency is at the variable most closely manipulated by the most governments. The world economy has seen a very slow and unsteady pace of growth, something that Minsky saw as the characteristic of a system overloaded with debt, and the governments are treading very softly in an attempt to work through a multi-year relaxation of the debt burden. This gentle process has demanded foreign exchange rates that are not rushing off in one direction or another, so they are intervening both against weakness and against strength, trying to keep the market quiet. They have been phenomenally successful. Trend following is dead as trends never really get going. So far this year, the euro’s range against the dollar is the lowest in the history of floating rates, about 3 times the allowed Bretton Woods range. This is not the only currency trading well within its historic range. However, we believe that this calm is not likely to continue if recessions break out and the debt burden begins to slow economic growth dramatically.
But, in the first half of this year, investors trying to read signals in the financial markets pushed by political and central bank dictates have struggled to keep up with the latest government moves as the rocking between too high and too low has become more frantic. Trends have been short-lived and violent, crossing the narrow range quickly. After the Fed introduced the ‘tapering’ timeline, financial markets began throwing tantrums. Although Bernanke has worked hard to ‘walk the line,’ proving again that he’s the market’s Johnny Cash, he has just made the markets’ moves dependent on the parsing of his utterance. Dressed in black at what is expected to be his final congressional testimony, he looks good, but does he understand that he is confusing and frustrating the markets? The Fed should be wary of the risk that the tight range and the increased confidence in government guidance will lead to a surge in US government bond yields and in global currency markets as well. As Minsky showed, these tight ranges – stability – will breed more instability and eventually lead to a whole new shift to a different reality, and that nature of that reality can be very hard to predict. Whether the next move is a break toward higher inflation or deflationary recession, governments everywhere will have struggle to control their money supplies, interest rate levels and fiscal positions in a way that will lead to healthy economic outcomes. Foreign exchange rates are likely to be much more volatile in this new world.
Europe Long-Term View See You in September…..
By Jonathan Clark
“See you in September. See you when the summer's through” - lyrics by Sid Wayne and Sherman Edwards. This is around the time of the year when head traders go on holiday, leaving instructions not to lose any money to those who remain. This is easier said than done. Volumes are down and trading is choppy and erratic as market participants don’t have strong convictions. This difficult trading environment usually ends in early September. This was the case last year when, following a slow uptrend, EUR/USD accelerated the pace of its uptrend on September 6 and rallied 4¼% during the subsequent six trading days. In 2011, the euro broke to the downside on September 1 and declined by 8½% during the subsequent month. On September 13, 2010, the euro turned higher and rallied by 12½% during the subsequent eight weeks. There are numerous other examples of this phenomenon during the past few decades of directionless trading in August followed by strong trends in September. Our research shows that late July and August is the time of year when selling volatility has historically proved profitable, provided the options expire by the start of the US Labor Day holiday in early September. This is typically when the markets return to full staff and is usually accompanied by the beginning of a strong directional move.
The next several weeks are likely to witness a continuation of the directionless trading, making the short- and medium-term cycles difficult to interpret. When this occurs we turn to the longer-term cycles and they argue the next significant event should be a low that was either seen last week or will be formed around the end of the month or during early August. Our strategy is to use any weakness seen during the next several weeks to buy European currencies. The policy of the Federal Reserve is likely to exacerbate the choppy trading as they increasingly link monetary policy to inflation and employment so the normal shifts in these data series add to volatility, but there is little follow-through buying or selling. Our best reading of the shorter cycles call for the single currency to form a medium-term peak during the next few trading days and the resistance between 1.3200 and 1.3225 has a good chance of holding. Only a close above this area will signal a spike higher to 1.3450, but this is less likely. By the start of next week, the single currency should turn lower and decline into the end of the month or early August. We are expecting the support at 1.2725 to contain any weakness seen and then the euro should turn up to begin a sustained uptrend. There is
an initial peak due in late August and this overall strength should last into December.
By John R. Taylor, Jr.
Ever since the Great Recession of 2008-2009, the foreign exchange markets have been buffeted by ever-increasing interference from government bodies, especially central banks, disrupting the day-today functioning of the market. In the old days, currency valuation was only one of the levers that governments had to move the market around. More important tools were money supply growth, interest rate levels, and fiscal policy. By changing the settings on these four instruments, overnments could control their economic growth, inflation and employment. The whole theory was conceived years ago by Jan Tinbergen, 1969 winner of the Nobel Prize for Economics. Currency was the step-sister of the other three, but in the aftermath of 2008, things changed as base money was growing through the roof, interest rates were at zero, and fiscal deficits were so high they could not be expanded. After the Greek crisis at the end of 2009 outlined the European problem (and everyone began to read the work of Hyman Minsky about debt instability), expansive fiscal policy became almost totally off limits. Then Bernanke’s August 2010 Jackson Hole speech ushered in the era of stuffing the economic goose with money, rendering monetary growth an unworkable variable, at least in its stimulative sense. With the impact of ‘tapering’ we can see that this variable still has teeth if governments are looking to slow the economy down, increase unemployment, and move closer to deflation, but of course, that is not what Tinbergen, Keynes and others saw as the value in these variables. So now, currency is at the variable most closely manipulated by the most governments. The world economy has seen a very slow and unsteady pace of growth, something that Minsky saw as the characteristic of a system overloaded with debt, and the governments are treading very softly in an attempt to work through a multi-year relaxation of the debt burden. This gentle process has demanded foreign exchange rates that are not rushing off in one direction or another, so they are intervening both against weakness and against strength, trying to keep the market quiet. They have been phenomenally successful. Trend following is dead as trends never really get going. So far this year, the euro’s range against the dollar is the lowest in the history of floating rates, about 3 times the allowed Bretton Woods range. This is not the only currency trading well within its historic range. However, we believe that this calm is not likely to continue if recessions break out and the debt burden begins to slow economic growth dramatically.
But, in the first half of this year, investors trying to read signals in the financial markets pushed by political and central bank dictates have struggled to keep up with the latest government moves as the rocking between too high and too low has become more frantic. Trends have been short-lived and violent, crossing the narrow range quickly. After the Fed introduced the ‘tapering’ timeline, financial markets began throwing tantrums. Although Bernanke has worked hard to ‘walk the line,’ proving again that he’s the market’s Johnny Cash, he has just made the markets’ moves dependent on the parsing of his utterance. Dressed in black at what is expected to be his final congressional testimony, he looks good, but does he understand that he is confusing and frustrating the markets? The Fed should be wary of the risk that the tight range and the increased confidence in government guidance will lead to a surge in US government bond yields and in global currency markets as well. As Minsky showed, these tight ranges – stability – will breed more instability and eventually lead to a whole new shift to a different reality, and that nature of that reality can be very hard to predict. Whether the next move is a break toward higher inflation or deflationary recession, governments everywhere will have struggle to control their money supplies, interest rate levels and fiscal positions in a way that will lead to healthy economic outcomes. Foreign exchange rates are likely to be much more volatile in this new world.
Europe Long-Term View See You in September…..
By Jonathan Clark
“See you in September. See you when the summer's through” - lyrics by Sid Wayne and Sherman Edwards. This is around the time of the year when head traders go on holiday, leaving instructions not to lose any money to those who remain. This is easier said than done. Volumes are down and trading is choppy and erratic as market participants don’t have strong convictions. This difficult trading environment usually ends in early September. This was the case last year when, following a slow uptrend, EUR/USD accelerated the pace of its uptrend on September 6 and rallied 4¼% during the subsequent six trading days. In 2011, the euro broke to the downside on September 1 and declined by 8½% during the subsequent month. On September 13, 2010, the euro turned higher and rallied by 12½% during the subsequent eight weeks. There are numerous other examples of this phenomenon during the past few decades of directionless trading in August followed by strong trends in September. Our research shows that late July and August is the time of year when selling volatility has historically proved profitable, provided the options expire by the start of the US Labor Day holiday in early September. This is typically when the markets return to full staff and is usually accompanied by the beginning of a strong directional move.
The next several weeks are likely to witness a continuation of the directionless trading, making the short- and medium-term cycles difficult to interpret. When this occurs we turn to the longer-term cycles and they argue the next significant event should be a low that was either seen last week or will be formed around the end of the month or during early August. Our strategy is to use any weakness seen during the next several weeks to buy European currencies. The policy of the Federal Reserve is likely to exacerbate the choppy trading as they increasingly link monetary policy to inflation and employment so the normal shifts in these data series add to volatility, but there is little follow-through buying or selling. Our best reading of the shorter cycles call for the single currency to form a medium-term peak during the next few trading days and the resistance between 1.3200 and 1.3225 has a good chance of holding. Only a close above this area will signal a spike higher to 1.3450, but this is less likely. By the start of next week, the single currency should turn lower and decline into the end of the month or early August. We are expecting the support at 1.2725 to contain any weakness seen and then the euro should turn up to begin a sustained uptrend. There is
an initial peak due in late August and this overall strength should last into December.
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