Bob's Currency Focus

Is it the end of the world as we know it?

The Fed’s bailout of insurance giant AIG is the latest spectacular episode in what has been one of the most frightening weeks in the history of global financial markets. On Monday Lehman Brothers became the largest (by a street) bankruptcy failure in the history of Corporate America. Also on Monday, Merrill Lynch, Lehman’s closest cousin on Wall Street, was taken over by Bank of America in a rushed deal, executed just before markets opened on Monday, when Merrill was certain to be the next guillotine victim of those shorting financial stocks. Today, we learn that Lloyds TSB and HBOS (the UK’s largest mortgage lender) are on the verge of a merger, forced upon HBOS, as their share price has plummeted so much in recent days that their market capitalisation value has plunged to farcical levels. And today the Russian stock market had to be closed after its index fell 17.5% in an hour. This follows a similar closure on Tuesday, after the index lost 20%. These are scary times and the impact is resonated across currency markets as well as equity markets, with the risk aversion Japanese yen slaying all before it. It is not a market for rational trading based upon the latest economic indicator releases and technical analysis charts, but rather it is a market to best avoid, unless the trader has massive risk tolerance levels. The volatility is resulting in huge swings across most major currencies and in particular any currency pair involving the US dollar, or the Japanese yen. Logic is out the window and wide shifts in sentiment towards what is happening in wider financial markets is forcing currencies in one direction or another. A look at the latest Commitment of Traders Report essentially shows a mediocre volume of open currency trading positions against the norm, which tells us 1) liquidity levels remain dangerously low and 2) currency movements are not being influenced to any great degree by speculative currency trading, but by the repatriation of funds across exchange rate borders, primarily to Japan and the US, resulting in the yen and the dollar appreciating significantly against the other majors. The yen has now appreciated to 2-year highs against the euro and the Aussie dollar and to multi-year highs against the high-yielding pound and Kiwi dollars. The carry trade has essentially been completely liquidated in the past 2 weeks although extreme negative market sentiment could see the yen gain further, particularly against the euro.

The current market is too risky and volatile and short stops are not working. Traders are best advised to avoid the dollar and yen and to stay away from the market until it settles, or else stick to pairs like EUR/GBP, AUD/NZD and EUR/CHF. Those stuck in open positions may need to sit them out or if brave enough, to enter the market at current range extremes, and collapse the two positions at the halfway point.

Bob B