Markets Shrug Off Geopolitical Tension

by Marc to Market

The US dollar is trading heavier against the euro, sterling and yen, but is somewhat firmer against the dollar-bloc in mostly subdued activity.  

Full liquidity will not return until next Tuesday. 

Sterling is trading at new 4-year highs today. After the strong employment data, more participants are looking for a test on the $1.70 level and above. For its part, the euro has built a base this week near $1.3800 and appears poised to return to last week high just above $1.3900.  

There have been three developments from the Europe to note.  First, excess liquidity appears to have risen in the Eurosystem.  At 132 bln euros yesterday, it is the highest since mid-March.   This may help stabilize EONIA.  One of the consequences of this is that the ECB is more likely to be able to sterilize the SMP holdings next week after failing to do so this week.  

Second, EU March auto sales rose for the seventh consecutive month.  The 10% increase brings it to 1.49 mln units.  UK sales rose 18%, and this accounted for about a third of the EU increase.  Recall that in 2012, the UK surpassed France as the second largest EU car market after Germany.  German sales increased 5.4%, encouraged by an increase in discounts.  

Third, France appears to have won a sympathetic hearing from EU about marginally slowing its deficit reduction efforts.  It is not exactly clear what this really means, as France has consistently overshot its deficit targets and has received forbearance more than once.  Moreover, Finance Minister Sapin promises that the fiscal targets will be respected.  Note that next Wednesday, France is to provide details of its long-term deficit reduction intentions.  

The main news from the Asia was China's announcement of a cut in required reserves for "qualified" rural banks.  The effect of this was to push down money market and swap rates.  Blunting this was the PBOC draining operations.  This week, it drained about CNY44 bln after injected about CNY55 bln last week. Some banks are looking for a cut in the required reserves for large banks later in the quarter (May or June). The dollar initially rose to its highest level against the yuan (~CNY6.2295) since March 21 before pulling back to finish little changed on the day (~CNY6.2190).

Against the yen, the dollar remains within yesterday's trading ranges.  Although as widely expected, the government did trim is economic assessment in light of the sales tax increase.  However, anecdotally, it seems that the economy is withstanding the increase better than expected.  This is what the finance minister indicated yesterday, and this appears to have been confirmed by the Reuters "Tankan" survey, which found the largest jump in sentiment among the large manufacturers since August 2007.   This coupled with anecdotal reports of businesses raising prices in excess of the retail sales tax would seem to undermine the likelihood of additional policy responses anytime soon.  

The highlights from the weekly MOF flow data include foreign investors returning to sell Japanese equities, after last week's hiatus after four weeks prior of selling.  The equity sales were more than offset by purchases of bonds and money market instruments. After having a voracious appetite last year for Japanese shares, foreign investor demand has cooled considerably and thus far this year, foreign investors have been net sellers.   They have sold a weekly average of JPY169.5 bln.  For their part, Japanese investors bought foreign bonds for the first time in four weeks.   They have sold a weekly average of JPY337 bln of foreign bonds this year.   

In the North American session, there will be some interest paid to the weekly initial jobless claims.  Recall last week, they fell to new cyclical lows of 300k and the smoothed 4-week average (316k) is approaching the cyclical low set last September (~305k).  Additional declines this week and it will likely spark talk of greater than 200k increase in April non-farm payroll.  

At the same time, Yellen was very clear yesterday: there remains a large gap between the Fed's objectives and the economic performance, especially the labor market conditions.  She suggested (for the first time?) that it may take until the end of 2016 to reach the Fed's inflation and employment targets.  She also continued to warn that inflation risks were still to the downside.  

Lastly, we note that the US, EU, Ukraine and Russia are to meet today.  However, a diplomatic solution seems unlikely at this juncture.  Indeed, the diplomatic effort, including by Germany exploring back-channels, has failed.  Another round of sanctions seems increasingly likely.  Putin appears to be betting that Europe and the US will not have the stomach for a sustained tough sanction regime.  Already reports suggest that many European businesses are cautioning against imposing new sanctions.   

Nevertheless, the markets do not seem to be particularly worried ahead of the long holiday weekend.  Gold remains heavy, straddling the $1300 area, nearly 2% off last Friday's high.  The euro remains firm, having made a marginal new high for the week.  The rouble is posting some corrective upticks after slipping earlier in the week.  Russian stocks are little changed, and Russian bonds are firmer.    

Threat of Deflation sends Euro to Three Week Lows

By: Marc to Market

The main impulse, today, is the heightened deflationary risk in the euro area, sparked by Spanish and German state inflation figures.  The euro area's flash CPI will be reported Monday ahead of next Thursday's ECB meeting.  

Since Draghi's comments that recognized that the euro's strength, while not a target of policy directly, was becoming a risk to the growth and inflation goals of the central bank, and Bundesbank President Weidmann apparently dropping his opposition to QE (in theory), the euro has slowly surrendering the gains scored in response to the do-nothing ECB meeting.

Spain reported a 0.2% decline in the preliminary reading of March CPI.  The market has expected an unchanged reading of 0.1% for the EU harmonized measure.   It is the lowest since Oct 2009.  In the euro-area measure, Spain is about 1/8.  However, the German states that have reported suggest slippage in the national estimate that will be reported in the North American morning.  The harmonized measure may ease below 1.0%.

Adding insult to injury, the real sector data has disappointed, as well.  Spanish retail sales recovered strongly last year.  Retail sales were contracted at an almost 12% year-over-year pace at the end of 2012.  In  September, it was rising a little more than 2%.  In February, it fell 0.5% after a 0.5% gain in January.

The French disappointment was just as disturbing.  Following news earlier this week of a further rise in unemployment, today France reported a 0.3% fall in February consumer spending on a year-over-year basis.  The Bloomberg consensus expected a 0.7% gain.  On the month, sales rose 0.1%, not 0.8% as was expected.

The net effect has been to boost expectations for ECB action next week.  The 1-year/1-year EONIA rate, which has become a popular way to gauge expectations, is falling today, as it has each day this week, for its longest streak in a year.  It stands at a 2-week low near 18 bp.   The heightened risks that the ECB responds come at the same time the rise in short-term US rates, sparked by the FOMC and Yellen's comments have not been reversed.  

This has sent the US-German 2-year spread above 30 bp, the highest since mid-2012 (~33 bp), which is essentially the high since the crisis.  Although it the relationship had broken down, over the long-term, we find it have been a useful guide.   Perhaps the fact that both sides are moving in opposite directions and the sheer magnitude is going to pull the euro back into its orbit.

At the same time, the LTRO payment announcement today will be closely watched.  Banks have stepped up their payments in recent weeks, and very little appears to have been rolled into the main repo operations.  Banks have paid down about 40 bln euro sin the past three week.  Excess liquidity in has fallen below 105 bln euros, which represents a new low since the LTRO's.

After taking out the FOMC low (~$1.3750) in North America yesterday, the soft data allowed European participants push through the door that was already open.  The euro found a bid ahead of $1.3700.  A break of there could set up a quick move toward the $1.3640-50 area.   The short-term speculative market has been accumulating a significant long euro position.  

In the futures market, the gross long position has risen consistently from about 67.6k contracted in early February to 118k contracts as of March 18.  The cost of holding euro positions has increased (interest rate differential) and the risk of ECB action next week has increased.   Late longs are in weak hands and we suspect that money management discipline is flushing out some of these.    However, many economists and analysts are warning of disappointment with the ECB, in which case the euro would likely recover by the end of next week.

Separately, the other theme that has emerged this week is the strength of the dollar-bloc currencies.  They are easily the strongest of the majors this week with 1.8%-2.0% gains and the Aussie leading the way.    It reached almost $0.9300 in Asia before pulling back.  The pullback has been shallow and we suspect the market is not down yet and will push toward $0.9340 and possibly $0.9400.   The technical trade idea suggested yesterday, the head and shoulders pattern in the euro against the Australian dollar, has continued to unfold.   Recall the key break was at A$1.50 and the measuring objective is A$1.42, with the initial target near A$1.4730.   It tested A$1.4780 today.

The New Zealand dollar is also extending its gains and approached $0.8700 today, a new 3-year high.  It finished 2013 near $0.8200.  It is the strongest major currency this quarter, gaining 5.8%.  On the other hand, the Canadian dollar is the second strongest currency this week, but is the weakest on the quarter, losing about 3.5%.  The US dollar is finding support near CAD1.10, but there too the market does not seem to have finished washing out the weak positions.    There has been a large rise in short Canadian dollar futures positions, in recent weeks.

The US reports February personal income and consumption and the University of Michigan consumer confidence.  These are not typically market movers.  The Fed's George, a hawk, speaks, and this means no push against Yellen's 6-month framework.    Lastly, we note that one mystery has deepened.  Yesterday the Fed reported its custody holdings jumped $54.2 bln.  This is the second large rise in a row for a combined $88.5 bln, after falling $104.5 bln in the previous week. 

Russia and the Birth of the Eurodollar Market

By Marc to Market

Talk that Russia could be behind the bulk of the more than $100 bln drop in the Federal Reserve's custody holdings for foreign central banks, in the week ending Wednesday has many observers scratching their heads. This could represent about 75% of their Treasury bond holdings according December Treasury data.  

As we noted earlier, rather than selling the Treasuries, Russia probably simply transferred them from the Federal Reserve out of the US. The motivation would be the threat of sanctions following this week's Crimean referendum.

There is precedent for this kind of behavior from Russia. Recall the origins of the Eurodollar market. The Eurodollar market has nothing to do the European Economic and Monetary Union (EMU) or the euro itself. Rather the Eurodollar market refers to dollars outside the US, initially Europe.

In 1956, the US and Soviet Union opposed British and French (and Israeli) invasion of Egypt (Suez Crisis). The US threatened to sell British pounds and intensify the pressure it was already experiencing in maintaining it peg to the dollar under Bretton Woods. It also threatened to veto the UK 's request for a large IMF assistance package. Russia witnessed the US willingness to use its financial acumen to impose its will on its special ally.

At roughly the same time, a reformist government came to power in the Hungary and among other things tried to leave the Warsaw Pact. The Soviet Union invaded. Russia feared that the US would use its financial superiority against it in protest. In 1957, Russia-based Narodny Bank shifted dollars from the US and deposited them in its branch in London. Voila, the birth of the Eurodollar market.

There were other advantages of this offshore market for US dollars beyond the Soviet Union's intentions. Those dollars were not subject to US interest rate cap or regulations. These dollars, as we know with the benefit of hindsight, became the basis for a new bank credit, and a critical part of international finance.

The logic now is that Russia is bracing for the next round of sanctions. The US and Europe are reluctant to confront Russia militarily. US and Europe did not confront Russia militarily after the Soviet Union invaded Hungary or Czechoslovakia, and it wasn't that Eisenhower or Johnson (the respective presidents at the time) were weak as some claim about Obama. Nor did President Bush confront Russia with arms when it invaded and continued to occupy parts of Georgia in 2008.

To be sure, the Federal Reserve does not publish the client list of who uses its custodial services. As we noted, some suggest it could be China diversifying reserves out of dollars and ostensibly into euros, which would help explain the persistent euro strength. However, we are a bit more skeptical of China in that it has a lot on its plate presently. The timing of the drop in custody holdings makes Russia a more likely suspect. The intervention by emerging market central banks, including Russia, seem far too small to account for $100 bln+ move in a week.

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Want To Become A Wolf On Wall Street ? Know These Numbers!

Elite traders are cocky. Felix Dennis perhaps said it best when he said that "Making money is certainly that one addiction I cannot shake." Dennis, like many other successful traders, believes that they will continue to make money. Their confidence comes from knowing the most intricate details about their trading. Remember that as a Forex trader you are a money manager and must keep track of how you are preforming. This can be done by reviewing your trading history and analyzing your trading journal. Thus should be done on a consistent basis. But wait, we still haven't told you what numbers you need to know ! Here are the eight metrics that each trader needs to calculate:

1. Percentage of winning trades(How many trades have you profitably close)?
2. Average Gain/Loss(The average of all winning and losing trades). If your average loss is bigger than your average gain and your winning percentage is not over 60%, you should rethink your trading strategy. 
3. Average Trade Duration(How long do you hold a trade for on average)?
4. Most Profitable Currency Pair(What is your bread and butter pair)? 
5. Drawdown (The percent decline from peak equity to a its trough)?
6. Run-up(Largest win streak in account)? 
7. Drawdown/Run-up Ratio( In dollar terms, how does your worst losing streak compare to your best winning streak)? 
8. Expectancy(Determine whether your system is profitable)? 

Canada's Central Bank Sparks Concern

On January 21, the Canadian dollar (CAD) hit a four-year low against the U.S. dollar (USD) amid concerns over the Bank of Canada and the U.S. Federal Reserve. The CAD broke through the C$1.10 mark, which has long been considered a psychological barrier that can have a drastic effect on future forex trading. However, the CAD did gain slightly before the close of the day in the North American market.

The fall of the CAD was said to originate the night before when the USD unexpected rose after news broke of possible cutbacks in the Federal Reserve’s program designed to stimulate the U.S. economy and domestic investing. No official announcement was ever made, but the article published in the Wall Street Journal stated that the Fed may drop its bond purchases to $65 billion per month from its current monthly purchases of $75 billion.

The reason why the CAD dropped from the news concerning the Fed is that investors are expected to start purchasing U.S. currency instead of Canadian. However, concerns about the Bank of Canada have been in play for some time and may come to a head in only a few days.

Late last year, the Bank of Canada dropped discussions about rate hikes after it had been suggesting they were on the horizon for nearly 18 months. This event immediately caused the CAD to waver on the market, which has appreciated the USD against the pair by more than 6 percent. A full 3 percent of this increase came in January 2014.

The executive director of foreign exchange sales at CIBC World Markets in Toronto, Don Mikolich, has agreed that CAD trading is at a downturn, stating, “The sentiment does continue to be quite firmly against Canada.” Mikolich continued by discussing the fact that the Bank of Canada is comfortable in the weakening of the currency. “It’s hard to say what levels they have in mind, ultimately, but I don’t think we’re there yet,” Mikolich said.

At the close of the trading day on January 21, the CAD was at C$1.0972 against the USD. The last time the currency pair had been this low was in September 2009 when the CAD fell to C$1.1019 against the USD.

The Bank of Canada is due to release two important updates later in the week that may also affect the CAD: its annual Monetary Policy Report and a decision on interest rates. However, interest rates are expected to stay fixed at 1 percent. 

2014 Could Be the Year of the U.S. Dollar

The United States dollar (USD) recently posted gains against the euro and the yen after minutes from the December meeting of the Federal Open Market Committee (FOMC) were released.
The minutes indicate two major developments: First, the U.S. Federal Reserve is on track to reduce its bond purchase program at a gradual pace. Second, the Fed's outlook for the U.S. economy is positive.

The FOMC minutes were released on Wednesday, January 8th. Earlier that day, the closely-watched National Employment Report from payroll technology firm ADP was also positive as it indicated that the private sector closed 2013 by adding 238,000 jobs in December. Forex traders responded quickly to the news, which caused the USD to rise against the euro and the yen by 0.3 percent.

Quite a few forex market analysts believe that scenarios similar to the one above will be more common in the year ahead. As the world's largest economy recovers from the Great American Recession and the global financial crisis, investing in the USD is expected to be a bullish move for the first half of the year.

USD Consensus for 2014
Trading the greenback is something that just about all forex traders get into in their lifetimes. The USD is part of the currency pairs known as the forex majors, which include the EUR/USD and the USD/JPY. The forecast for the euro and the yen in 2014 is not the brightest. In fact, many analysts believe that both the euro and the yen will perform very poorly from January to June.  The EUR/USD seems to even be on a downtrend from the year 2008, continually slipping lower in price than previous years.

The European Union economies are expected to languish over the next few months. The Bank of Japan is expected to flood the market with cash for the purpose of offsetting the immediate effects of a sales tax increase. The U.S. economy, on the other hand is expected to experience a gradual recovery in terms of employment, real estate and consumer spending.

The consensus on the USD index, which is currently at about 81.14, is that it will reach 85 by December 2014. The euro, however, could drop to $1.27 by the end of the year. This is not the first time that analysts are forecasting a significant fall of the euro, but they seem to be a bit more certain this time around.