The Same, But Different
By John R. Taylor, Jr.
If you squint hard enough, so that your eyes are just slits, sometimes different things look very similar. The same is true in looking at cyclical patterns. We can get fooled into thinking that some market and economic parallels are very obvious but, when looking closely at individual situations within those markets, the variations can be dramatic enough to make you wonder if the major cycle is even there. This generality applies very well to a comparison of the mid-1994 to 1997 period with the past year-and-a-half and what we project for the next year, or so. For us at FX Concepts, our research and database draw us to the comparison of these two periods as we believe that there is a statistically valid market cycle that runs about 17½ years in length with a two standard deviation span running from a bit over 15 years to a bit under 20 years. There seems to be a slight tendency for these cycle lengths to extend over the last century, and we have surmised that this could be a result of the longer human lifespan, but 17 to 18 years is close enough. Many market and economic measures seem to follow this rhythm, but individual series almost always differ in
length and often do not even arrive in the same sequential order. Interest rates and the FX value of the dollar are an interesting example. In 1994, US interest rates were the first indicator that the dollar would eventually be moving higher as the Fed moved the overnight rate higher in February. Interest rates lurched higher. The dollar continued erratically lower for more than a year, until it bottomed in April 1995. The dollar struggled to find its bottom against the Deutsche mark but, within a month, it began to fly higher against the yen. This time around, the dollar reversed its negative trend against the yen in October, 2012 – almost exactly 17½ years after its previous reversal; however, this time US interest rates seemed to turn after the yen, making their sharp reversal in May 2013. However, during a very flat period, the low for the 2-yr was in August 2011and for the 5-yr and 10-yr it was last July, coinciding with Draghi’s bumblebee speech. Taking the 2-yr bottom as the most important, a questionable choice, the recent Japanese move came 15 months after the interest rate reversal, compared to 14 months in 1995. But the lurch happened after the yen move. Comparing emerging markets, they began moving higher in 1991 and peaked in the summer of 1997, when Asia began to collapse, about a year before the dollar and global economies began to slow. This time the emerging markets jumped higher very quickly in early 1999, while the developed markets staggered along for another few years, arguably going through a weak upcycle and then drooping into this summer, when they are picking up again. This puts the European and US projected fall growth spurt in the 1996 area – about a year before the emerging markets got into serious trouble. Parallel to that period, developed equity markets are moving higher while emerging ones are already dropping. For the big guys, the good times should last for a while,
but the smaller guys will struggle.
We see strong parallels between these two periods and so do many other technical analysts, but the underpinnings to these markets are not the same. Back in the 1990’s, the 10-yr was almost always over 6%, but now it is just above 2.5%. Fed Funds dropped below 3% in 1991, a big deal at the time, but now they are basically free. As the market picked up from its mid-cycle doldrums in 1996, Fed Funds rates were 5.25%, up quite a bit from the low levels of January 1994 but, this time, rates have not moved at all – a bad sign. Somehow, the Fed must be successful at ‘tapering’ and even moving rates higher, while the economy and equities move up as they did years ago. If not, when the crisis hits the emerging markets – which came almost exactly 2 years after the yen began to weaken last time, or next October this time – there will be very few weapons to limit the market and economic decline. Let’s hope that Bernanke is successful and the economies grow right through this tightening. If he can get Fed Funds off the floor without driving bond yields so high that housing is harmed, he will have pulled off a miracle.
Beware of the Obvious Trades
By Jonathan Clark
There are very clear reasons why the New Zealand dollar should outperform the Australian dollar. These reasons are mainly related to the health of the New Zealand economy compared to that of the Australian economy and the nature of the respective countries’ exports. Australia is witnessing a slowing economy due to the underperformance of their largest trading partner, China, falling prices for the commodities they export, the end of the mining boom, and a decrease of capital flows into the country. The housing boom also appears to be ending as building approvals for June fell 6.9% from May and were 13.0% lower than a year ago. The unemployment rate is rising and the market has priced in two ¼% interest rate cuts for the remainder of the year. New Zealand rebuilding following the earthquakes in Christchurch and the Canterbury region has boosted construction to the highest level in five years. The number of new houses has been rising for the last two years while the unemployment rate is falling. Perhaps the most compelling argument for the AUD to underperform the NZD relates to exports – especially to China, which is refocusing its economy from building infrastructure to increasing consumer consumption. This favors New Zealand, which mainly exports food, over Australia where the largest commodity exports are iron-ore, gold, coal, oil and natural gas. The downtrend in AUD/NZD has been very aggressive since March of 2011, losing 18%, and it is approaching oversold levels.
Since the major low in currencies in March of 2009, the strongest has been the New Zealand dollar, which gained 60%, followed by the Australian dollar, which gained 41%. Our longterm rate-of-change (ROC) measure shows the AUD/NZD is approaching the (blue) oversold level and, in the past 28 years, when this was surpassed the crossrate quickly formed a significant low. In addition, it is near the bottom of the (red) downtrend channel. It is difficult to know what will cause the crossrate to reverse direction, but it could be related to China, where Premier Li Keqiang’s growth floor of 7% is at risk of being breached. If significant Chinese stimulus measures are announced, this would tend to favor Australia over New Zealand.
AUD/NZD is approaching a significant low that should be formed by the start of September at the latest and probably sooner. The crossrate should fall to 1.1100 at a minimum, but we cannot rule out a spike lower to 1.0850, at which time it would be extremely oversold and likely to make a sharp reversal lasting two to three months. Only a close above 1.1610 will immediately turn the outlook positive, but we are not expecting any significant strength before the middle of August. Take profits if you are short.
By John R. Taylor, Jr.
If you squint hard enough, so that your eyes are just slits, sometimes different things look very similar. The same is true in looking at cyclical patterns. We can get fooled into thinking that some market and economic parallels are very obvious but, when looking closely at individual situations within those markets, the variations can be dramatic enough to make you wonder if the major cycle is even there. This generality applies very well to a comparison of the mid-1994 to 1997 period with the past year-and-a-half and what we project for the next year, or so. For us at FX Concepts, our research and database draw us to the comparison of these two periods as we believe that there is a statistically valid market cycle that runs about 17½ years in length with a two standard deviation span running from a bit over 15 years to a bit under 20 years. There seems to be a slight tendency for these cycle lengths to extend over the last century, and we have surmised that this could be a result of the longer human lifespan, but 17 to 18 years is close enough. Many market and economic measures seem to follow this rhythm, but individual series almost always differ in
length and often do not even arrive in the same sequential order. Interest rates and the FX value of the dollar are an interesting example. In 1994, US interest rates were the first indicator that the dollar would eventually be moving higher as the Fed moved the overnight rate higher in February. Interest rates lurched higher. The dollar continued erratically lower for more than a year, until it bottomed in April 1995. The dollar struggled to find its bottom against the Deutsche mark but, within a month, it began to fly higher against the yen. This time around, the dollar reversed its negative trend against the yen in October, 2012 – almost exactly 17½ years after its previous reversal; however, this time US interest rates seemed to turn after the yen, making their sharp reversal in May 2013. However, during a very flat period, the low for the 2-yr was in August 2011and for the 5-yr and 10-yr it was last July, coinciding with Draghi’s bumblebee speech. Taking the 2-yr bottom as the most important, a questionable choice, the recent Japanese move came 15 months after the interest rate reversal, compared to 14 months in 1995. But the lurch happened after the yen move. Comparing emerging markets, they began moving higher in 1991 and peaked in the summer of 1997, when Asia began to collapse, about a year before the dollar and global economies began to slow. This time the emerging markets jumped higher very quickly in early 1999, while the developed markets staggered along for another few years, arguably going through a weak upcycle and then drooping into this summer, when they are picking up again. This puts the European and US projected fall growth spurt in the 1996 area – about a year before the emerging markets got into serious trouble. Parallel to that period, developed equity markets are moving higher while emerging ones are already dropping. For the big guys, the good times should last for a while,
but the smaller guys will struggle.
We see strong parallels between these two periods and so do many other technical analysts, but the underpinnings to these markets are not the same. Back in the 1990’s, the 10-yr was almost always over 6%, but now it is just above 2.5%. Fed Funds dropped below 3% in 1991, a big deal at the time, but now they are basically free. As the market picked up from its mid-cycle doldrums in 1996, Fed Funds rates were 5.25%, up quite a bit from the low levels of January 1994 but, this time, rates have not moved at all – a bad sign. Somehow, the Fed must be successful at ‘tapering’ and even moving rates higher, while the economy and equities move up as they did years ago. If not, when the crisis hits the emerging markets – which came almost exactly 2 years after the yen began to weaken last time, or next October this time – there will be very few weapons to limit the market and economic decline. Let’s hope that Bernanke is successful and the economies grow right through this tightening. If he can get Fed Funds off the floor without driving bond yields so high that housing is harmed, he will have pulled off a miracle.
Beware of the Obvious Trades
By Jonathan Clark
There are very clear reasons why the New Zealand dollar should outperform the Australian dollar. These reasons are mainly related to the health of the New Zealand economy compared to that of the Australian economy and the nature of the respective countries’ exports. Australia is witnessing a slowing economy due to the underperformance of their largest trading partner, China, falling prices for the commodities they export, the end of the mining boom, and a decrease of capital flows into the country. The housing boom also appears to be ending as building approvals for June fell 6.9% from May and were 13.0% lower than a year ago. The unemployment rate is rising and the market has priced in two ¼% interest rate cuts for the remainder of the year. New Zealand rebuilding following the earthquakes in Christchurch and the Canterbury region has boosted construction to the highest level in five years. The number of new houses has been rising for the last two years while the unemployment rate is falling. Perhaps the most compelling argument for the AUD to underperform the NZD relates to exports – especially to China, which is refocusing its economy from building infrastructure to increasing consumer consumption. This favors New Zealand, which mainly exports food, over Australia where the largest commodity exports are iron-ore, gold, coal, oil and natural gas. The downtrend in AUD/NZD has been very aggressive since March of 2011, losing 18%, and it is approaching oversold levels.
Since the major low in currencies in March of 2009, the strongest has been the New Zealand dollar, which gained 60%, followed by the Australian dollar, which gained 41%. Our longterm rate-of-change (ROC) measure shows the AUD/NZD is approaching the (blue) oversold level and, in the past 28 years, when this was surpassed the crossrate quickly formed a significant low. In addition, it is near the bottom of the (red) downtrend channel. It is difficult to know what will cause the crossrate to reverse direction, but it could be related to China, where Premier Li Keqiang’s growth floor of 7% is at risk of being breached. If significant Chinese stimulus measures are announced, this would tend to favor Australia over New Zealand.
AUD/NZD is approaching a significant low that should be formed by the start of September at the latest and probably sooner. The crossrate should fall to 1.1100 at a minimum, but we cannot rule out a spike lower to 1.0850, at which time it would be extremely oversold and likely to make a sharp reversal lasting two to three months. Only a close above 1.1610 will immediately turn the outlook positive, but we are not expecting any significant strength before the middle of August. Take profits if you are short.
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