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

admin — Tue, 23 Jun 2009 00:08:30 +0000

“]

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.

Green Shoots: a sentiment shift toward currency strength again

admin — Mon, 01 Jun 2009 01:30:38 +0000

A number of weeks ago I wrote a post entitled, “An Imbalance Developing in GBP/USD.” We were waiting for the sentiment shift to come and it has arrived. I’m not saying that the Pound will definitely be higher some time from now as in some “the trend is your friend” context, but rather our bias for trades should be long due to this sentiment shift. Last month the Fed for the first time acknowledged that they are confident about an economic recovery occuring. This is what they said in March:

Information received since the Federal Open Market Committee met in March indicates that the economy has continued to contract.

This is what they said at the latest FOMC meeting:

Information received since the Federal Open Market Committee met in March indicates that the economy has continued to contract, though the pace of contraction appears to be somewhat slower.

For those of you new to central bank parlance, this means the Fed expects a turn around. The market had been pricing this in beforehand as a result of signs of slowing deterioration in economic data, however, there is no evidence that this view has been fully priced in yet. This supports a positive bias for currencies against the dollar along with the Gestalt Shift of a perception for an economic turn around. The logic behind this is that money flowed in to US treasuries and other assets after the violent asset deleveraging last year with the idea that US assets are safe and the US Fed was most proactive in flooding the markets with money, thus giving the US the best chance to recover first. However, as risk appetite improves due to this gestalt shift of a perceived economic turnaround, investors are becoming more choosy and putting their money in countries with better yielding assets and taking it out of a country where inflation could put the deficit in an even worse condition. That said, the UK is not that much better, but they were also proactive and were over punished due to the carry trade unwinding of last year. Some other clues supporting this view are falling Tbond prices and Eurodollar interest rate futures showing some weakening.

The Euro would also be a good candidate for a long bias because it’s viewed as second in line as a world reserve currency but I would not recommend putting a lot on a long EUR/USD position just because the economy is still trying to recover and would be really sensitive to Euro strength as it is an export economy.

As always, don’t take this as investment advice, but rather as strategies to think better about approaching markets.

the gestalt shift » green shoots

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

Green Shoots: a sentiment shift toward currency strength again