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Currencies Surge Yet Again; Markets Inch Closer to "Of Course" Moment
Written by article default Thursday, 14 October 2010 07:41
Another day and another bout of broad based USD weakness. This time, the catalyst seems to have come initially from a solid bout of earnings out of the US, led by some impressive numbers out from JP Morgan, and then accelerated on the news that the Singapore central bank has unexpectedly announced that they will allow the local currency to appreciate in an effort to curb inflation threats. The Euro has surged towards 1.4100, Aussie is now just shy of parity, the Yen is very close to its record highs against the buck, while the Franc has already managed to break to yet another record high. However, we continue to be quite wary of the latest surge in currencies, with technical studies screaming for a correction, and the parabolic price action warning that we could be on the verge of a major capitulation.Interestingly enough, the latest surge has come in Asian trade, and this is a development that is less than common. More often than not we expect to see some consolidation in Asian trade, if not even some mild profit taking on currency longs. This latest run-up in Asian markets therefore does not sit well with us, and after already seeing many markets having exceeded or matched their daily average true ranges, we wonder just how much more juice there is in the tank for additional currency buying. At this point, two of the critical psychological levels yet to be tested are parity in Aussie, and 80.00 in Usd/YEN. At this point we certainly can not rule out a test of these levels, but once broken, how much more room is there? We would argue not all that much.
One of our favorite trades out there right now is long Usd/YEN by 80.00, and our own in-house proprietary indicator is highly supportive of this trade. As it stands, our Speculative Sentiment Index (“SSI”) currently has retail traders at a dramatic 8.5:1 long Usd/YEN. The SSI is used as a formidable contrarian indicator, with retail traders more often than not moving in the wrong direction. As such, on the surface, the indicator would suggest that more pain is to come for retail traders. However, as we have studied this indicator over time, there is always a point at which retail traders will finally be right, but unfortunately, they are no longer in the trade. We call this the “of course” moment, the moment at which retail positions are stopped out and the market then reverses sharply in the direction that they had been holding their position. This leaves the traders with nothing more to say than “of course”.
USD/YEN SPECULATIVE SENTIMENT INDEX
By comparison to some of the other majors, retail traders are only 1.7:1 short Eur/Usd, and 1.5:1 short Gbp/Usd. Usd/Chf and Usd/Cad are the only other stand-outs, but even these ratios are below 5x. Ideally, in order to really get excited about establishing a long Usd/Yen position, we would love to see Usd/Yen continue dropping towards 80.00 with the ratio also dropping off below 8x. This would suggest that retail traders are no longer fighting the trend and have either stopped out or have given up. Once this “of course” moment is behind us, we will then be quite excited to establish fresh Usd/Yen longs.
It is true that the markets have been ignoring short-term overextended technical readings of late, but fundamentals should also not be ignored and certainly make a strong case for Yen weakness as well. The Japanese economy is riddled with economic uncertainty, and the idea that the Yen is safe-haven currency is laughable. It is certainly true that the Yen is a low yielding currency, but in a global environment where low yields are not uncommon, what then really is so attractive about the Yen. Furthermore, it is more than clear that Japanese officials are quite uncomfortable with their currency at current levels, and have already taken action to stem the appreciation.
There is still plenty of room for additional intervention, and we certainly would expect to see another round from the Bank of Japan should this Yen appreciation persist. Finally, with Usd/Yen so well offered and arguably by cyclical lows, the idea of fading this position and buying, has to be attractive to investors that are looking for long-term positions that will not bring with it the unattractive negative carry. To be long Usd/Yen at current levels with plenty of upside in the cards, and to not have to pay for it, sounds quite compelling to us. For now, it is merely a question of timing.
On the broader global macro front, the fall in the buck over the past several weeks has been directly correlated to expectations for another round of monetary policy accommodation from the Fed. At this point, it seems that the greater risk from here for some form of a let-down, with the market seemingly having already priced this in. We have also been hearing a lot of talk from various dissenting members within the Fed, who have been questioning the effectiveness of additional monetary easing. These members include, Fed Hoenig, Fisher, Lacker, Dudley, and Yellen. Surely these comments carry some weight, and with the latest earnings out of the US, the need for further accommodation might be called into question some more. As a direct result, we would therefore expect to see some profit taking on the QE2 trade which could also spark a major reversal in the markets. Fed Chair Bernanke is slated to speak tomorrow, and the Fed chief could shed further light on the matter. Investors might start to focus more on the “if necessary” part of the language in the monetary policy statement, which will no doubt warrant some position adjusting.
One other interesting idea, which is more of an idea and probably carries no weight, is the potential fall-out from the latest margin adjustments on retail foreign exchange trading in the US. Surely many traders were overleveraged and positions were margined out by brokers. If we can safely assume that a good majority of these positions were USD longs, then how much of the latest sell-off in the buck can be attributed to USD selling on margin calls. Again, we doubt this has really factored into broader price action, but still interesting nonetheless.
REMINDER: The Euro has now put in 26 consecutive daily closes higher than the previous daily low. This sequence will need to be broken to officially force a shift in the trend. Wednesday’s low by 1.3910 is a long ways off at present, so it is quite possible that we will soon see 27 consecutive days of this pattern.
Looking ahead, the economic calendar is extremely light in European trade, with the only notable releases coming from the ECB Monthly Report at 8:00GMT, and the German Economic Institute Bi-Annual forecasts at 9:00GMT. Broader global macro fundamentals and flows will play a heavier role in price action, and it will be interesting to see how European traders choose to respond to this latest wave of volatility. US equity futures are bid at present, while commodities are also higher on similar correlations, led by fresh record highs in gold towards $1380.
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