Posts Tagged ‘ EUR/USD ’

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Forex Geek Review – Any Good?

John Kicklighter, on Monday December 13, 2010, 11:33 pm EST

Risk appetite continues to march higher – at least that is what is to be presumed given the consistent advance in those traditional benchmarks for investor sentiment. However, for those that are more critical of how they position; there is a glaring lack of tangible fundamental support in this otherwise consistent advance.

• EURUSD and S&P 500 Threaten Bullish Trends but Reversal Risk Very High
• China Avoids another Interest Rate Hike by Hiking Reserve Ratios yet Again
• European Financial Concerns Threaten Euro Zone Stability, Global Credit Markets

Risk appetite continues to march higher – at least that is what is to be presumed given the consistent advance in those traditional benchmarks for investor sentiment. However, for those that are more critical of how they position; there is a glaring lack of tangible fundamental support in this otherwise consistent advance. And, while it is not generally a good strategy to fight prevailing trends – it’s been said that it is better to make money than it is to be right – leveraging oneself behind the prevailing market winds without a thought to the motivation to a run is a surefire way of being caught off guard when that moment of capitulation occurs. For attentive traders, cracks in bull run for everything risk-based have been clear for some time now. perhaps the best sign of strained speculative appetite is the general health of the equities market. The S&P 500 may have marched on to a fresh two-year high this past week, with the Dow inevitably soon to follow; but there has been an obvious lack of momentum behind what would under normal conditions be labeled breakout. from this favored speculative asset class, we have seen a number of justifications as to why it is overbought ranging from a restrained forecast for growth to its surpassing two standard deviations away from a projected moving average. yet the most telling evidence of the market’s struggle is seen in the fundamentals that ushered the run to its current position.

If the outlook for growth is drab enough to cast doubt over the currently high level of earnings being reported by banks, why do market participants continue to invest into the already-mature advance? The short answer is: stimulus. rather than a true fundamental reason for market strength; government intervention is instead a distortion of capital flows. With the Fed’s regular Treasury’s buying scheme to fulfill a $600 billion stimulus program laid out on November 4th, the world’s most influential monetary policy authority has essentially taken lower interest rates into its own hand. The economic aim of this effort is to keep thaw lending to long-term capital investments and consumers; but those looking to use the access to funds for speculative means usually win out. many analysts at this point have pointed out the remarkable correlation between positive performance from stocks on the days that the central bank conducts its permanent open market operations (POMO). Cheap funds translate into high leverage; and while the Federal Reserve may not intend to support speculative interests, their efforts nonetheless show greater results in boosting capital gains than economic performance. And, in the end, both results deliver the same results – a temporary reprieve from reality.

Eventually, stimulus will have reached the extent of its influence or investor uncertainty will simply overwhelm the limits of the already taxed money supply tools. when that time comes; the higher the markets have run on the temporary support, the more dramatic the correction will be. what will be responsible for shaking market participants to their senses? There are a number of potential catalysts. The most prevalent driver is European financial health. this regional economy is struggling to simply prevent a crisis of confidence and it seems either severe recession for some or a tremendous bailout for all are the two options open to the region. one outcome will spur fear the other will just delay the inevitable. a potent threat that has been is still overlooked is the Chinese lending and asset bubble that officials refuse to truly confront. And, then there is the US where stimulus continues to feed unsustainable deficits. Take your pick.

DailyFX Carry Trade Index

Risk Indicators:

DailyFX Volatility Index

What is the DailyFX Volatility Index:

The DailyFX Volatility Index measures the general level of volatility in the Currency market. The index is a composite of the implied volatility in options underlying a basket of currencies. our basket is equally weighed and composed of some of the most liquid currency pairs in the Foreign Exchange market.

In reading this graph, whenever the DailyFX Volatility Index rises, it suggests traders expect the currency market to be more active in the coming days and weeks. since carry trades underperform when volatility is high (due to the threat of capital losses that may overwhelm carry income), a rise in volatility is unfavorable for the strategy.

USDJPY 25 Delta Risk Reversals 3 Month

What are Risk Reversals:

Risk reversals are the difference in volatility between similar (in expiration and relative strike levels) FX calls and put options. The measurement is calculated by finding the difference between the implied volatility of a call with a 25 Delta and a put with a 25 Delta. when Risk Reversals are skewed to the downside, it suggests volatility and therefore demand is greater for puts than for calls and traders are expecting the pair to fall; and vice versa.

We use risk reversals on USDJPY as global interest are bottoming after having fallen substantially over the past year or more. both the US and Japanese benchmark lending rates are near zero and expected to remain there until at least the middle of 2010. this attributes level of stability to this pairs options that better allows it to follow investment trends. when Risk Reversals move to a negative extreme, it typically reflects a demand for safety of funds – an unfavorable condition for carry.

Reserve Bank of Australia Expectations

How are Rate Expectations calculated:

Forecasting rate decisions is notoriously speculative, yet the market is typically very efficient at predicting rate movements (and many economists and analysts even believe market prices influence policy decisions). To take advantage of the collective wisdom of the market in forecasting rate decisions, we will use a combination of long and short-term, risk-free interest rate assets to determine the cumulative movement the Reserve Bank of Australia (RBA) will make over the coming 12 months. We have chosen the RBA as the Australian dollar is one of few currencies, still considered a high yielders.To read this chart, any positive number represents an expected firming in the Australian benchmark lending rate over the coming year with each point representing one basis point change. when rate expectations rise, the carry differential is expected to increase and carry trades return improves.

Highest And Lowest Yields:

The Interest rate used to benchmark the currency basket is the 3 months Libor rate

Is Carry Trade and risk appetite rising or falling? Discuss how to trade yields and market sentiment in the DailyFX Forum

Additional Information

What is a Carry Trade

All that is needed to understand the carry trade concept is a basic knowledge of foreign exchange and interest rates differentials. each currency has a different interest rate attached to it determined partly by policy authorities and partly by market demand.when taking a foreign exchange position a trader holds long position one currency and short position in another. each day, the trader will collect the interest on the long side of their trade and pay the interest on the short side. If the interest rate on the purchased currency is higher than that of the sold currency, the result is a net inflow of interest. If the sold currency’s interest rate is greater than the purchased currency’s rate, the trader must pay the net interest.

Carry Trade as a Strategy

For many years, money managers and banks have utilized the inflow and outflow of yield to collect consistent income in times of low volatility and high risk appetite. Holding only one or two currency pairs would invite considerable idiosyncratic risk (or risk related to those few pairs held); so traders create portfolios of various carry trade pairs to diversify risk from any single pair and isolate exposure to demand for yield. However, even with risk diversified away from any one pair, a carry basket is still exposed to those conditions that render this yield seeking strategy undesirable, such as: high volatility, small interest rate differentials or a general aversion to risk. Therefore, the carry trade will consistently collect an interest income, but there are still situation when the carry trade can face large drawdowns in certain market conditions. as such, a trader needs to decide when it is time to underweight or overweight their carry trade exposure.

Written by: John Kicklighter, Currency Strategist for DailyFX.com

To receive John’s reports via email or to submit questions or Comments about an article; email jkicklighter@dailyfx.

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EURUSD and S&P 500 Threaten Bullish Trends but Reversal Risk Very High