Roth, the chairman of the Swiss National Bank (SNB) declared back in March of this year that the CHF had risen too high against their trading partners in the rest of Europe (the EU25 constitutes 62% of their export market), imperiling their Current Account balance. The SNB actively intervened; selling Swiss francs and buying Euros to maintain 1.51 or so. You can see the initial effect (EUR appreciating against CHF), and the resulting tight trading band (+/- 150 pips) in the succeeding 6 months.

Another example is the $/JPY. The Japanese economy is export-driven, and their largest trading partner is the US (22% of the total). The BoJ is famous for actively intervening in the markets. You can see from this chart the level at which they get rather uncomfortable- about 88 or so. They actively intervened back in February. I am not sure about in October, but it certainly was a good level from which to be bullish.

Trichet has made many comments recently about the TWI (trade-weighted) strength of the Euro, and the weakness of the dollar. While the ECB is not likely to intervene, I imagine that any approach to the previous high of 1.60 will be met with a lot of jawboning.

While trading limits like $/JPY of 88 can be done with the spot, options offer alternatives when the spot exhibits very low volatility like the EUR/CHF. You can actually profit from no movement at all with spread structures, and very limited downside risk. The topic is beyond the scope of this article, but you can reach me at stafford.paul1@gmail.com.

Please visit my website at www.4Xtradertools.com to sign up for my weekly Currency Briefing

Since almost everything we look at is valued in dollars, it is sometimes hard to separate the effects of a strong or weak dollar from real economic trends. For example, gold is hitting record levels vs. the $, and oil may finally punch through the $73 level. Are these real effects? Well, one interesting measure is the Gold/Oil ratio. Historically, it has hovered between 10 and 15. In February of 2009, it rose to nearly 30. Now it is back to about 14.7, or well within its historical range. If you look at gold vs. other currencies, it is not at historic highs- for example it remains 30% below its highs in AUD. In actuality, demand for commodities is still very low. Witness the “ghost fleet” of 500 freighters (20% of the fleet size) idled off Singapore due to lack of international shipping, or the Baltic Dry Index, etc. High commodities prices are simply the result of a weak dollar.

The S&P is now trading at a massive 27:1 trailing P/E ratio, and 140x trailing P/E on reported earnings. This is three times the levels of the tech bubble. I believe one reason (amongst others) is the depreciation of the dollar. Another direct indication is the $ index, now at 76 (nearly its 10 yr low of 72 in July of 08), and a far cry from its highs over 117.

We must ask- is this a low from which the $ stages a comeback, or just the beginning of a long term slide? I fear I must come down on the side of further depreciation over the long term.

• USA budget deficits will inevitably worsen due to lack of political will
• The inexorable move away from the $ as the reserve currency due to its mismanagement. This has already started (China, oil producers)
• Implicit monetary policy- the Fed will not move strongly against inflationary pressures
• Carry trade effects as other countries exit QE and raise interest rates earlier ($ becomes a funding currency)
• Sentiment- when markets lose confidence in a currency (witness the Pound when it withdrew from the ERM), sharp declines and high volatility will dominate

I always try to look for disconfirming evidence, and one positive element for the dollar might be an improvement in the current account deficit due to a weaker dollar driving exports. However, the continued offshoring of manufacturing, and import of energy argue against this having a large net positive effect.

This doesn’t mean that the dollar index will drop monotonically in the next 6 months or year. Exogenous events, black swans (think Iran and nuclear missiles aimed at Europe) can all reverse direction for many months. After all, the $ index reversed its decade-long decline from 117 to 72 back to 89 in only 4 months as risk aversion set in, in late 2008. But the future cannot belong to the dollar.

Paul Stafford is an accomplished investor, business expert, and trader. He  performs practical fundamental currency market analysis in his weekly “Stafford Weekly Currency Briefing” at 4xtradertools.com

The market fears that people will stay at home and if 100 million people die due to an epidemic like in 1918 then the global economy would accelerate into a giant depression. This is scary, and there is a small possibility that something like this could happen as history teaches us. However, it’s our job as traders not to trade coulds, woulds, and shoulds. What’s happening right now is a classic example of “framing” behavior. I explain this in the special report, but basically this means that the market has a bias to focus on too narrow of a view of available information and use that to draw conclusions or predictions about price. There are other big problems in both Europe and the US that must be considered: the debt situation in the US, how far the Eurozone is willing to go with pumping money into the economy, etc. We saw market reactions to the SARS outbreak in 2003 and the Foot and Mouth disease in the UK in 2007. In both cases there was an initial flight to liquidity and then return to initial levels and higher.

Any further fast moves down in EUR/USD will be illiquid ones. Even though sentiment seems to lean toward USD strength, there may be a possibility to enter long on the Euro after a spike down and hold for a couple hundred pips profit after price swings in this random zone driven by fluctuating market sentiment. The key is to keep leverage small and limit your risk to the downside in case the epidemic does indeed turn out to be what everyone has feared. Note this is only for a spike down due to the swine flu outbreak, NOT news on bank failures or the ECB implementing massive money injections. It is important to have a reason for entering other than just price.

I would like to close by saying that I am by no means making light of the situation. I was living in Singapore during the SARS outbreak of 2003 and can relate to the unfortunate circumstances. My prayers are for protection of people across the globe.

All the best in your trading,

Kris M

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