the gestalt shift

Shift from “Green Shoots” perception of economic recovery: look at USD, CAD

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Daily chart of WTI Crude Oil [source: Dukascopy

Last week marked a turning point in perceptions of a global economic recovery emerging (a.k.a. “Green Shoots”) especially with this week’s FOMC meeting on the horizon. The new sentiment in the markets is captured well by today’s headline in the Financial Times: “Recession Worries Rattle Markets.” Let’s take a look at what going on across multiple markets to get a clue for currency trades: Oil tried to rally upon the increasing instability in Iran but couldn’t hold above the $70/bbl figure. Stocks went down upon several weak figures, including industrial production, empire state manufacturing, and others. The remarks by the IMF that China could recover soon and pick up global demand was also not well received.

The Euro has been trading in a declining range against the dollar (see my previous post about factors weighing Euro outcomes for more information) and particularly hasn’t been able to respond positively to good news supporting the “green shoots” perception such as last week’s larger than expected and increasing ZEW survey outcome. The pound has been ranging at high levels due to a perception that the UK may still turn around fast and the political situation is now under control, however the sentiment shift is affecting its upside as well. Traders who got in in the 1. 40s and 1.50s when I originally started speaking about the imbalances should start reducing their longs and move toward a more neutral bias or take their big 1000 pip profits altogether.

In short the shift in perception away from economic recovery has led to Dollar strength if it is looked at as an individual currency (this can be done with a mathematical algorithm and I will start posting my plots of this, especially if I get reminders). Currencies are starting to show signs of weakening but have not yet given way to Dollar strength yet. A trigger that could reverse currencies would be a remark from the Fed that although there have been signs of recovery, they will not tighten for a long time or that housing has shown no clear signs of bottoming. Traders are focused now on the Fed’s exit strategy and the housing market. If the housing market doesn’t show convincing signs of a recovery, other sectors such as jobs and retail won’t be able to recover either. These are just possibilities, but traders should consider any catalysts that could start driving currencies down and supporting the dollar. Remember our formula: imbalance + sentiment shift = price movement. In this case, I believe a medium term imbalance is the behavior of traders: they started bidding up currencies dramatically over the last couple of months due to a framing bias (focusing solely on the notion that the economy was recovering). It is not a strong imbalance, although there needs to be a newer, stronger belief to emerge in the market before the dollar weakens further. Meanwhile, the Canadian dollar (CAD) has weakened rapidly, no doubt due to weakening crude prices. Because of greater risks to the downside in crude oil after its rapid increase on the recovery story and the BOC’s concern of Canada’s ability to export with a stronger currency during this time, the CAD is particularly vulnerable.

Monday, June 22nd, 2009, by admin and is filed under "Behavior, Performance, Strategy, Trades, Uncategorized, mind of a trader, fed exit plan, forex sentiment, green shoots ". You can leave a response here, or send a Trackback from your own site.