When analyzing forex, nothing is more satisfying than establishing a
strong correlation between a particular currency pair and another
quantifiable investment vehicle. You see – we fundamental analysts love
to kid ourselves that we can actually explain what’s going in the
forex markets, but it’s only when you can visually observe (and
statistically confirm) a correlation can you actually pretend that this
self-assuredness is justified.
On that note, I found myself looking at in interesting chart today:
the EUR/USD vs. CHF/USD vs. S&P 500 Index. My purpose in drawing
this particular chart was to ascertain how risk appetite (represented
by the S&P) is being reflected in forex markets. As you can see,
two observations can immediately be made. CHF/USD very closely tracks
the S&P (or vice versa), while the EUR/USD similarly mirrored the
S&P for most of the last 12 months, before suddenly diverging in
November 2010.
Untangling the Puzzle of Risk Appetite
When analyzing forex, nothing is more satisfying than establishing a
strong correlation between a particular currency pair and another
quantifiable investment vehicle. You see – we fundamental analysts love
to kid ourselves that we can actually explain what’s going in the
forex markets, but it’s only when you can visually observe (and
statistically confirm) a correlation can you actually pretend that this
self-assuredness is justified.
On that note, I found myself looking at in interesting chart today: the EUR/USD vs. CHF/USD vs. S&P 500 Index. My purpose in drawing this particular chart was to ascertain how risk appetite (represented by the S&P) is being reflected in forex markets. As you can see, two observations can immediately be made. CHF/USD very closely tracks the S&P (or vice versa), while the EUR/USD similarly mirrored the S&P for most of the last 12 months, before suddenly diverging in November 2010.
On that note, I found myself looking at in interesting chart today: the EUR/USD vs. CHF/USD vs. S&P 500 Index. My purpose in drawing this particular chart was to ascertain how risk appetite (represented by the S&P) is being reflected in forex markets. As you can see, two observations can immediately be made. CHF/USD very closely tracks the S&P (or vice versa), while the EUR/USD similarly mirrored the S&P for most of the last 12 months, before suddenly diverging in November 2010.
Hedging High Forex Uncertainty
Tuesday, February 15, 2011
In forex, everything is relative. That is no less the case for forex
volatility, which is low relative to the spikes in 2008 (credit
crisis) and 2010 (EU Sovereign debt crisis), but high relative to the
preceding 5+ years of stability. On the one hand, volatility is
approaching a two year low. On the other hand, analysts continue to
warn of high volatility for the foreseeable future. Under these
conditions, what are (currency) investors supposed to do?!
Hedging High Forex Uncertainty
In forex, everything is relative. That is no less the case for forex
volatility, which is low relative to the spikes in 2008 (credit
crisis) and 2010 (EU Sovereign debt crisis), but high relative to the
preceding 5+ years of stability. On the one hand, volatility is
approaching a two year low. On the other hand, analysts continue to
warn of high volatility for the foreseeable future. Under these
conditions, what are (currency) investors supposed to do?!
Forex Markets Look to Interest Rates for Guidance
Friday, February 11, 2011
There are a number of forces currently competing for control of
forex markets: the ebb and flow of risk appetite, Central Bank currency
intervention, comparative economic growth differentials, and numerous
technical factors. Soon, traders will have to add one more item to their
list of must-watch variables: interest rates.
Interest rates around the world remain at record lows. In many cases, they are locked at 0%, unable to drift any lower. With a couple of minor exceptions, none of the major Central Banks have yet raised their benchmark interest rates. The same applies to most emerging countries. Despite rising inflation and enviable GDP growth, they remain reluctant to hike rates for fear that they will invite further speculative capital inflows and consequent currency appreciation.
Emerging
markets countries can only toy with inflation for so long. Over the
medium-term, all of them will undoubtedly be forced to raise interest
rates. The time horizon for G7 Central Banks is a little longer, due to
high unemployment, tepid economic growth, and price stability. At a
certain point, however, inflation will compel all of them to act. When
they raise rates – and by much – may well dictate the major trends in
forex markets over the next couple years.
Australia (4.75%), New Zealand (3%), and Canada (1%) are the only industrialized Central Banks to have lifted their benchmark interest rates. However, the former two must deal with high inflation, while the latter’s benchmark rate is hardly high enough for carry traders to take interest. In addition, the Reserve Bank of Australia has basically stopped tightening, and traders are betting on only one or two 25 basis point hikes in 2011. Besides, higher interest rates have probably already been priced into their respective currencies (which is why they rallied tremendously in 2010), and will have to rise much more before yield-seekers take notice.
China (~6%) and Brazil (11.25%) are leading the way in emerging markets in raising rates. However, their benchmark lending rates belie lower deposit rates and are probably negative when you account for soaring inflation in both countries. The Reserve Bank of India and Bank of Russia have also hiked rates several times over the last year, though again, not yet enough to offset rising prices.
Instead, the real battle will probably be fought primarily amongst the Pound, Euro, Dollar, and Franc. (The Japanese Yen is essentially moot in this debate, and its Central Bank has not even humored the markets about the possibility of higher interest rates down the road). The Bank of England (BoE) will probably be the first to move. “The present ultra-low rates are unsustainable. They would be unsustainable in a period of low inflation but they are especially unsustainable with inflation, however you measure it, approaching 5 per cent,” summarized one columnist. In fact, it is projected to hike rates 3 times over the next year. If/when it unwinds its quantitative easing program, long-term rates will probably follow suit.
Interest rates around the world remain at record lows. In many cases, they are locked at 0%, unable to drift any lower. With a couple of minor exceptions, none of the major Central Banks have yet raised their benchmark interest rates. The same applies to most emerging countries. Despite rising inflation and enviable GDP growth, they remain reluctant to hike rates for fear that they will invite further speculative capital inflows and consequent currency appreciation.
Emerging
markets countries can only toy with inflation for so long. Over the
medium-term, all of them will undoubtedly be forced to raise interest
rates. The time horizon for G7 Central Banks is a little longer, due to
high unemployment, tepid economic growth, and price stability. At a
certain point, however, inflation will compel all of them to act. When
they raise rates – and by much – may well dictate the major trends in
forex markets over the next couple years.Australia (4.75%), New Zealand (3%), and Canada (1%) are the only industrialized Central Banks to have lifted their benchmark interest rates. However, the former two must deal with high inflation, while the latter’s benchmark rate is hardly high enough for carry traders to take interest. In addition, the Reserve Bank of Australia has basically stopped tightening, and traders are betting on only one or two 25 basis point hikes in 2011. Besides, higher interest rates have probably already been priced into their respective currencies (which is why they rallied tremendously in 2010), and will have to rise much more before yield-seekers take notice.
China (~6%) and Brazil (11.25%) are leading the way in emerging markets in raising rates. However, their benchmark lending rates belie lower deposit rates and are probably negative when you account for soaring inflation in both countries. The Reserve Bank of India and Bank of Russia have also hiked rates several times over the last year, though again, not yet enough to offset rising prices.
Instead, the real battle will probably be fought primarily amongst the Pound, Euro, Dollar, and Franc. (The Japanese Yen is essentially moot in this debate, and its Central Bank has not even humored the markets about the possibility of higher interest rates down the road). The Bank of England (BoE) will probably be the first to move. “The present ultra-low rates are unsustainable. They would be unsustainable in a period of low inflation but they are especially unsustainable with inflation, however you measure it, approaching 5 per cent,” summarized one columnist. In fact, it is projected to hike rates 3 times over the next year. If/when it unwinds its quantitative easing program, long-term rates will probably follow suit.
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