Tuesday, October 21, 2008

Currency Markets a Dangerous Sea to Swim

Currency Markets have entered a state of panic these past few weeks and there is very little in the way of profitable trading to be made, with wild swings the norm on any currency pair that includes the US dollar and the Japanese yen. The US dollar in particular has reached valuation levels against some currencies that were unimaginable just 3 months ago. While I had been calling the dollar undervalued since the beginning of the year, the steep nature of the dollar’s rise is greatly out of proportion with the shift in economic fundamentals for the leading currency pairs and the dollar’s rally is now overdone. A glance at the commitment of traders report for any of the past number of weeks, a report that details the number of open currency positions on the Mercantile Exchange, makes for interesting reading as it clearly indicates that the dollar’s current appreciation has little or nothing to do with traders bets on various currencies. The dollar has appreciated as sharply as it has done because of the credit squeeze and the shortage of dollars on the open market and also thanks to the repatriation of funds back into dollar assets, primarily from the emerging markets, as investors unwind their riskier assets.

The end result is a total distortion of currency markets with some of the smaller currencies at or near capitulation status. The yen’s sharp appreciation is one of the major problems and as long as the Japanese currency remains as strong as it currently is, we will not get normality back to the markets. The yen has appreciated over 30% against Australian Dollar since July and is up 20% against most other major currencies in that period, excluding the US dollar against which it has gained 7%. In the past month, the US currency itself has gained almost 20% against the Canadian dollar, its largest trading partner.

What does all this mean for currency traders? It means the market is unpredictable and dangerous to trade. It is largely a fruitless exercise trading intra-day because fear is the King and fear rises or subsides depending upon how stock markets perform and these are currently swinging madly from one side to the other without warning. Technical indicators mean little or nothing in this market with currency prices sailing through support and resistance points as if they didn’t exist. Economic data is also largely ignored as stories about credit problems, bank rescues and fiscal bailouts take precedence.

What should one do? Nothing! Sit on the sidelines until liquidity levels reach something akin to normal. One should also remember that when liquidity levels do normalise, the US dollar and the Yen will come under intense selling pressure. Positional trading is also dangerous right now because while the value trade would appear to be to sell the dollar or the yen, the result tends to be the opposite as both currencies continue to benefit unfairly from the broader market uncertainty and traders can be left holding positions with huge deficits. EUR/GBP is the only currency pair I like at the moment and with neither side having a hold on direction it can be lucrative to trade in either direction. The range looks to be from 0.77 to 0.7850 at the moment and I have also noticed that in recent weeks, the pound usually does better during the morning session while the euro then retaliates during the US session.

Trade safely, if at all in this market, and avoid the dollar and the yen.

Bob B - Oct 21