Currency Trader Magazine 2007.01

8/6/2019 Currency Trader Magazine 2007.01

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January 2007Volume 4 No. 11

Strategies, News, and Analysis for FX Traders

EMERGING

CURRENCIES:New opportunities

for FX traders p. 18

ANALYZING

THE OTHER DOLLARS:

Canadian, Aussie,

New Zealand bucks p. 8

CURRENCY

CHARACTERISTICS:

Dollar/Canada

behavior p. 24

ADVANCED STRATEGY:

The new Iron Cross p. 30

THE LATEST ON

China and reserve

diversification p. 14


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Contributors . . . . . . . . . . . . . . . . . . . .6

Global Markets

The death knell

for Canadian bulls? . . . . . . . . . . . . . .8Oh no, Canada: The USD/CAD pair

has staged one of its biggest rallies in

years as the Canadian dollar loses

ground vs. its U.S. cousin.

By Currency Trader Staff

The high yielders:Aussie and kiwi dollar updates . . . .11After laying low in the early part of

2006, the dollars down under have

come back strong.

By Currency Trader staff

On the MoneyReserve diversification, Part II . . . .14What is the U.S. doing to ensure

the Chinese government will not alter

the $700 billion it has in U.S. dollar

reserves?

By Barbara Rockefeller

Emerging market currencies:

A new FX dimension . . . . . . . . . . . .18Retail trading in emerging-market

currencies is a growing business.Are the opportunities in these

new markets worth the risks?

By Richard Lee

Trading Strategies

Dollar-Canada by the numbers . . . .24The latest entry in our series of

currency behavior articles tells you

what you need to know about the

USD/CADs typical price action.

by Thom Hartle

Advanced Strategies

The new Iron Cross . . . . . . . . . . . . .30The long history of the D-mark/pound

and now the euro/pound offers many

lessons about economic policies

and currency fluctuations.

By Howard L. Simons

CONTENTS

2 January 2007 CURRENCY TRADER

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4/534 January 2007 CURRENCY TRADER

CONTENTS

Have a question about something youve seen inCurrency Trader?

Submit your editorial queries or comments to

[email protected].

Looking for an advertiser?Consult the list below and click on the company name for a direct link to the ad in this months

issue ofCurrency Trader.

Index of advertisers

Spot Check . . . . . . . . . . . . . . . . . . . . 36New Zealand dollar

A look at the numbers behind the

New Zealand dollars recent scorching

performance and the odds it will continue.

By Currency Trader Staff

Currency Futures . . . . . . . . . . . . . .40Currency futures and fund manager

performance.

Industry News . . . . . . . . . . . . . . . . .41One Refco client gets restitution;

others still fighting

A judge ruled in favor of one RefcoFX.com

client, but other customers are still fighting to

regain their account balances.

International Market Summary . .42

Global News Briefs . . . . . . . . . . . . .44

Global economic calendar . . . . . . . . .46Key dates for currency traders.

Events . . . . . . . . . . . . . . . . . . . . . . . . .48Conferences, seminars, and other events.

Key concepts . . . . . . . . . . . . . . . . . . . .48

References and definitions.

New products and services . . . . . . . .49

Forex Trade Journal . . . . . . . . . . . .50If it aint broke

FXCM

Forex.com

NewsTrader Pro

Buysellorgetout.com

InterbankFX CMS Forex

Currency Trader Bookstore

International Traders Expo New York

TradeGuider

MetaStock
mailto:[email protected]:[email protected]


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Editor-in-chief: Mark Etzkorn

[email protected]

Managing editor: Molly Flynn

[email protected]

Contributing editors: Jeff Ponczak

([email protected]),

David Bukey ([email protected])

Contributing Writers:

Marc Chandler, Barbara Rockefeller

Editorial assistant and

Webmaster: Kesha Green

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Publisher,

Ad sales East Coast and Midwest:

Bob Dorman

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Ad sales

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Volume 4, Issue 1. Currency Traderis published monthly by TechInfo, Inc.,150 S. Wacker Drive, Suite 880, Chicago, IL 60606. Copyright 2007TechInfo, Inc. All rights reserved. Information in this publication may not bestored or reproduced in any form without written permission from the publisher.

The information in Currency Tradermagazine is intended for educational pur-poses only. It is not meant to recommend, promote or in any way imply theeffectiveness of any trading system, strategy or approach. Traders are advisedto do their own research and testing to determine the validity of a trading idea.Trading and investing carry a high level of risk. Past performance does notguarantee future results.

For all subscriber services:www.currencytradermag.com

A publication ofActive Trader

CONTRIBUTORSCONTRIBUTORS

Howard Simons is president of Rosewood

Trading Inc. and a strategist for Bianco

Research. He writes and speaks frequently on a

wide range of economic and financial market

issues.

Thom Hartle (www.thomhartle.com) is

director of marketing for CQG and a contribut-

ing editor to Active Trader magazine. In a career

spanning more than 20 years, Hartle has been a

commodity account executive for Merrill Lynch,

vice president of financial futures for Drexel

Burnham Lambert, trader for the Federal Home Loan Bank of

Seattle, and editor for nine years ofTechnical Analysis ofStocks

& Commodities magazine.

Richard Lee is a currency strategist at Forex Capital

Markets LLC. Using both fundamental models and technical

analysis applications, he contributes regularly to DailyFX and

Bloomberg. He has extensive experience in trading spot cur-

rency, options, and futures markets. Before joining the research

group, Lee traded forex, equities, and equity derivatives for aprivate equity group. He has bachelors degrees in economics

and French with an emphasis in international business.

Barbara Rockefeller(www.rts-forex.com) is an interna-

tional economist with a focus on foreign exchange. She has

worked as a forecaster, trader, and consultant at Citibank and

other financial institutions, and currently publishes two daily

reports on foreign exchange. Rockefeller is the author of

Technical Analysis for Dummies (For Dummies, 2004), 24/7

Trading Around the Clock, Around the World (John Wiley & Sons,

2000), The Global Trader (John Wiley & Sons, 2001), and How to

Invest Internationally, published in Japan in 1999. A book tenta-

tively titled How to Trade FX is in the works.
http://www.thomhartle.com/http://www.rts-forex.com/http://www.rts-forex.com/http://www.thomhartle.com/


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http://www.interbankfx.com/


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A

fter several years of practicallyone-way bullish trade for theCanadian dollar, many tradersare saying 2006 may have

marked the end of the mega-rally, which tookthe currency to an 18-year high vs. the U.S. dol-lar in May 2006 (Figure 1).

Ironically, this has occurred around the sametime the U.S. buck suffered a sharp downturnvs. most major currencies (see Dollar break-down: Solid signal or red herring? CurrencyTrader , December 2006). However, a retreat inglobal energy prices and weakening Canadianexports have contributed to a decliningCanadian dollar in recent months. Some saythe bullish party is over for the currency, and

traders should expect it to continue grindinglower in 2007.A longer-term look at U.S. dollar/Canadian

dollar (USD/CAD) action shows the pairfalling from the $1.6100 area in January 2002 to$1.0950 in May 2006. According to DavidPowell, currency analyst at Ideaglobal, sincelast spring the Canadian dollar has sold off considerably inlarge part because of sentiment turning against it.

Dollar/Canada has broken a long-term downtrend line

on the weekly chart and has started a new pattern of high-er highs and higher lows into year-end 2006, pushing to justshy of $1.1600 in late December (Figure 2).

The days of glory are now passed,says Charmaine Buskas, economist at

Moodys Economy.com. The rally isclearly over.

Decelerating growth

Because Canada is an oil-exportingnation, the substantial drop in energyprices is one of the first market-turningfactors market watchers have pointedto in recent months. Also, the CADshigh level into mid-2006 was a drag onits export picture; demand forCanadian imports has slowed, espe-cially as economic numbers in the U.S.

GLOBAL MARKETS

CANADIAN DOLLAR AT A GLANCE

Average USD/CAD daily range (past 40 days): 0.0068

Average USD/CAD weekly range (past 26 weeks): 0.0157

52-week high/low: 1.1797/1.0927

US CAN

Prevailing interest rates (%): 5.25 4.25

Next central bank meetings: 1/31/07, 3/21/07 1/16/07, 3/6/07

GDP (annualized growth) Q3 2006* Q2 2006 Q1 2006

US CAN US CAN US CAN2.0 1.7 2.6 2.0 5.6 3.6

*Estimate All data as of Jan. 2

A slack energy market and weakening exports are threatening the Canadian dollars

long uptrend vs. the U.S. buck.

The death knell forCanadian bulls?


The recent bounce in the U.S. dollar vs. the Canadian dollar has

analysts opining the CADs four-year dominance in the pair may be over.

FIGURE 1 END OF CAD MEGA-RALLY?

Source: TradeStation

BY CURRENCY TRADER STAFF


9/53CURRENCY TRADER January 2007 9

Canadas primary trade partner have begun to weaken.

Recent Canadian growth, manufac-turing, and trade figures have sur-prised economists on the downside,which has led some analysts to reducetheir 2006 year-end forecasts and 2007

projections.In the third quarter of 2006,

Canadian growth numbers retreatedto a weaker-than-expected 1.7 percentgross domestic product (GDP) reading a sharp drop from 3.6 percent and2.0 percent growth in the first and sec-ond quarters, respectively.

The annual rate was the lowestincrease in three years as the coolinghousing and manufacturing sectorsand lower government spending offset

a minor rebound in exports, saysAmanda Mason, associate internation-al economist at Northern Trust Co.

We recently lowered our forecastsfor 2006 and 2007, says JonathanBasile, vice president at Credit Suisse.Originally, Credit Suisse economistssaw potential for 2.8 percent GDPgrowth in 2006, but in light of recentdata, that forecast has been revised to2.7 percent.

Basile originally forecast a 2.6 per-cent 2007 GDP figure, but now expects

a 2.2 percent GDP performance.Buskas forecasts a 2.6 percent GDP

reading this year; a reading belowpotential, which is considered to beat the 3.0 percent mark.

U.S. demand slowing

As the U.S. economy has slowed inrecent months, that impact has trickledup to Canada.

Eighty six percent of Canadianexports go to the U.S., Buskas says.

Canada exports a variety of items tothe U.S., including manufacturedgoods such as autos and housing-relat-ed products. Recent economic data hasrevealed a rising inventory-to-salesratio in Canada.

That means supplies run ahead of

demand, Basile says. Its a red flagfor growth.However, Basile adds the situation

is a classic cyclical adjustment. Itshappening in the middle of the expan-sion and now we are getting to a pointwhere certain important export sectorsare slowing down.

Dwindling trade surplus

Also, Canadas buoyant trade surplusfrom recent quarters has been dwin-

Since bottoming in late-May 2006, the USD/CAD rate has rallied more than six

percent.

FIGURE 2 WEEKLY TREND CHANGE


continued on p. 10
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dling recently.The trade surplus has taken a severe hit over the past

year, notes John Shin, economist at Lehman Brothers.Trade is a crucial component for the growth outlook in

Canada.Shin forecasts a 2.6-percent GDP reading for Canada in

2007 and points to data showing a monthly trade surplus ofC$3.8 billion from October 2006, downfrom a C$7.7 billion surplus as recent-ly as December 2005.

Inflation

Core inflation readings are modestlyabove the BOCs 2-percent target. As ofOctober, core CPI came in at 2.3 per-cent on a year-over-year basis.

Pointing to the current inventoryoverhang, Credit Suisses Basile says itcould end up lowering goods prices,which would lower core inflation.

Monetary policy

Although some currency traders hadbegun to price in a cut in official short-term rates in Canada in the first quar-ter, as of late December players haveshifted their view on monetary policyexpectations.

The official short-term rate stands at4.25 percent, with the next Bank ofCanada (BOC) meeting scheduled for Jan. 16. Beyond that, another meeting is scheduled forMarch 6. Most market watchers do not expect the BOC tocut rates in the first quarter 2007.

The market has largely priced out the probability of acut in the first quarter, says Ideaglobals Powell.

Lehman Brothers Shin expects the BOC to remain onhold throughout 2007. Ideaglobal analysts expect the BOCto remain on hold until the end of the second quarter, atwhich point they expect a 25 basis-point cut to 4.00 percent.

Given that the economic conditions have deceleratedand because inflation is very well contained, there is defi-nitely no reason for the BOC to make any moves until wesee another quarter of data, says Moodys Economy.comsBuskas.

She does, however, see potential for a rate cut in the sec-ond quarter.

Whats ahead for dollar/Canada?

From early September 2006, a clear uptrend channel formedin dollar/Canada, with the pair moving from $1.10 to$1.1591 in late December. Most market watchers expect thattrend to continue into the New Year. Deteriorating econom-

ic conditions within Canada are seen as a major driver forfurther Canadian dollar weakness, and analysts cite U.S.conditions as a key factor: Weaker-than-expected economicconditions in the U.S. could weigh even more on the

Canadian outlook.Basiles global FX team projects a move toward $1.20 over

the next 12 months. Lehman Brothers Shin says his firm

targets a move toward $1.25 by year-end 2007.Buskas also sees room for depreciation in the Canadian

currency ahead, with a move to $1.18/1.20. She saw fairvalue around the $1.23/1.25 level, which is more in linewith historical averages.

Cross rates

Traders looking for opportunities on the crosses may wantto study the short CAD/long Australian dollar play

(Figure 3).Buskas highlights this opportunity, given it is lookinglike the Reserve Bank of Australia will deliver a rate hike inthe next few months. With Australian rates currently at 6.25percent, there already is a 200-basis-point yield spread,she explains.

Buskas says another factor favoring the Australian dollarvs. the Canadian currency in 2007 is the fact that Australiais more leveraged to the Asian cycle and China continues toexpand, while Canada is more leveraged to the U.S.

For more analysis of the USD/CAD pair, see Dollar-Canada bythe numbers.

GLOBAL MARKETS continued


The Canadian dollar has lost ground vs. the Aussie dollar, a trend some analysts

believe will persist.

FIGURE 3 CANADA/AUSSIE CROSS

Source: www.advfn.com



At the start of the NewYear, two of the so-cal-led high-yielding cur-rencies the Austra-

lian dollar and the New Zealand dollar have shown solid uptrends in recentmonths.

While another rate hike may be in

the works for Australia, can both cur-rencies continue their upward paths?Lets take a look at some of the keyfactors driving these currencies.

Whats bolstering the Aussie?

Since early October, the Australiandollar/U.S. dollar pair (AUD/USD)has moved from just above 0.7400 toaround 0.7950 in early January (Figure1).

Renewal of the Reserve Bank of

Australias (RBA) tightening cyclewas seen as a key supporting factorfor the Aussie dollar in 2006. Withshort-term official rates at 6.25 per-cent, some market watchers expectanother hike at the Feb. 6 meeting,which would bump the rate up to 6.50percent.

With core inflation near the topend of the RBA inflation target, theRBA is likely to deliver a rate hike,says Charmaine Buskas, economist at

Pausing twice along the way, the AUD/USD has rallied strongly since October,

pushing above 0.7900 in December.

FIGURE 1 PUSHING HIGHER


In recent months, the Australian and New Zealand currencies have returned to their high-flying ways.

The high yielders:

Aussie and kiwi dollar updates

BY CURRENCY TRADER STAFF

AUSTRALIAN DOLLAR AT A GLANCE

Average USD/AUD daily range (past 40 days): 0.0053

Average USD/AUD weekly range (past 26 weeks): 0.0117

52-week high/low: 0.7930/0.7015

AUS US


Next central bank meetings: 2/6/07 1/31/07, 3/21/07


AUS US AUS US AUS US2.2 2.0 1.9 2.6 3.1 5.6


continued on p. 12



Moodys Economy.com. There is anexpectation that yields will continue to

favor the Aussie dollar. Positive inter-est-rate differentials and the draw ofhigh yields should continue to under-pin the Aussie dollar moving ahead.

Broad-based U.S. dollar weaknesshas also fed the Aussie/dollar rally.

The dollar index fell from a high of92.63 at the end of 2005 to around 84 inlate December, notes Prakriti Sofat,strategist at the G-10 desk forIdeaglobal Ltd. in Singapore. (For moreanalysis of the dollar indexs down

move, see Dollar breakdown: Solidsignal or red herring?Currency Trader,December 2006.)

Also, strong gains in global com-modities have been a bullish theme inrecent years for the Aussie dollar.Recent strength in metals prices hassupported the Australian dollar andwill be an important driver goingahead.

The direction of global commodityprices, particularly the base metals,

will influence the direction of theAussie against most of the majors in the coming months,says Ruth Stroppiana, economist at Moodys Economy.com.

A glance at a long-term chart shows the AUD/USD pairhas stiff resistance at the 0.8000 region, which has cappedgains in recent years (Figure 2).

Growth outlook: A better 2007?

In 2006, Moodys Economy.com forecasted gross domesticproduct (GDP) growth at 2.4 percent. Weak consumer

spending and a soft housing market are the two main fac-tors weighing on the growth picture.

However, Stroppiana believes the future looks bright forAustralia.

We expect Australia to recover from slowing consump-tion by boosting exports due to the long-awaited supplyresponse to the minerals boom, she says. We expectAustralian GDP to expand by 3.1 percent in 2007.

Sofat also saw room for improvement this year.The pace of dwelling construction

recovery has slowed on account of

recent interest-rate increases, but for-ward-looking indicators and the lowvacancy rate suggest a gradual pickup in the year ahead, he says.

Inflation readings have been themain factor sparking the RBAhikes. InNovember, inflation readings breached the central banks 2-3 per-cent target in the third quarter, comingin at 3.05 percent year-over-year.

Improving interest-rate differentialsvs. the U.S. could support theAussie/dollar into the first quarter of

GLOBAL ECONOMY continued

The Aussie dollar is now approaching 0.8000 vs. the U.S. dollar, a general levelthat has turned back the currency in the past.

FIGURE 2 STIFF RESISTANCE


NEW ZEALAND DOLLAR AT A GLANCE

Average USD/NZD daily range (past 40 days): 0.0058

Average USD/NZD weekly range (past 26 weeks): 0.0142

52-week high/low: 0.7071/0.5927

NZ US


Next central bank meetings: 1/25/07 1/31/07, 3/21/07


NZ US NZ US NZ US1.3 2.0 1.4 5.6 2.2 5.6

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2007, with perhaps even a test of theresistance at 0.8000 on the horizon.

However, traders should monitorChinese growth, as weaker-than-expected performance in China could,in turn, damage Aussie exportprospects and ultimately weigh on theAussie dollar.

New Zealand dollar

A look at the weekly NewZealand/U.S. dollar (NZD/USD)chart shows a strong rally in thekiwi from around 0.5930 in late-June

2006 to the early-January readings justshy of 0.7100 (Figure 3). Being one ofthe highest interest rates in the devel-oped world at 7.25 percent has been amain driver for the gains in the kiwidollar.

The Reserve Bank of New Zealand(RBNZ) meets next on Jan. 25. At itsJuly meeting, the bank reintroduced atightening bias, given the rise inupside risks to the medium-term infla-tion outlook, Sofat says.

Uncertain interest-rate outlook

In the Dec. 15 edition ofGlobal Economy This Week, analystsat Credit Suisse wrote a rate hike in early 2007 is heavilydata dependent. We think at this stage the decision is tooclose to call and we have assigned a 50-percent probabilityto a rate hike in either January or March 2007.

Some analysts, however, say steady policy is likely earlyin the year, with potential for a rate cut by mid-2007 if infla-tion data improves. The RBNZ targets inflation to average1-3 percent.

The 3.5 percent reading in the third quarter 2005 is not

ideal, but a good portion is driven by now-fading oilprices, says Sean Callow, senior currency strategist atWestpac Institutional Bank. We look for 2.7 percent by theend of 2006 and 2.2 percent in 2007.

The economy is running close to full capacity and thehigh New Zealand dollar is hurting exports, so rapidgrowth seems unlikely, Callow adds.

Westpac predicts 2006 GDP to be at 1.8 percent, with aretreat to 1.4 percent in 2007. Moodys Economy.comexpects growth at 2.0 percent in 2006 vs. 2.4 percent in 2007.

Consumers continue to be the mainstay of the kiwieconomy, says Glenn Levine, economist at MoodysEconomy.com. The big question mark in 2007 is whether

businesses will start spending again after putting up theshutters in 2006. The stronger currency is also a worry andhas begun to crimp export growth through the second halfof 2006.

The kiwi chart

Analysts say room for additional upside action in thekiwi/dollar is possible in early 2007, but then tradersshould be on guard for a reversal.

We are modestly bullish on the New Zealand dollar inearly 2007 due to its ongoing yield appeal and the danger of

another RBNZ hike, Callow says. Obviously, it is veryexpensive to be short the New Zealand dollar. But as theworld economy cools and the high New Zealand dollarcontinues to hurt New Zealand exporters, the kiwi shouldfinally start to soften.

He sees a short-term push above the 0.7000 level, but aneventual retreat back below 0.6700 by early summer.

Moodys Economy.coms Levine held a negative view. Hesees the potential for the kiwi to fall below the 0.6000 levelby the third quarter.

We are bearish on the kiwi dollar and anticipate a steadydecline in 2007, as the RBNZ is given scope to cut rates ear-lier than expected, he says.

The New Zealand dollar's rally vs. the U.S. dollar has been one of the strongest

moves among major currency pairs in recent months.

FIGURE 3 SECOND-HALF BURST




The biggest threat to the dollar and to U.S.prosperity is the chance the Chinese govern-ment will dump its roughly $700 billion in dol-lar-denominated reserves, as it has hinted it will.

The sum of $700 billion is only fairly large in the forexuniverse, but the psychological effect of such action would be huge. It would reverberate throughout the financialworld, inducing others to diversify reserves into euros, theBritish pound, the low-yielding Japanese yen, and even

zero-yielding gold.Reserve diversification has already become a big deal.

The Bank for International Settlements recently reportedthe dollar has slipped from 67 percent of the worldsreserves to 65 percent. On Dec. 18, the Iranian governmentdirected its central bank to switch all its external accountsto the euro. Over the past year, Banco Central de Venezuela

raised the percentage held in euros from 5 percent to 15 per-cent (its total reserves are $35.9 billion), with the UnitedArab Emirates choosing to move as much as 8 percent of its$24.9 billion reserves into euros. The central bank ofIndonesia is also seeking a higher proportion of euros in itstotal reserves of $39.9 billion.

In its year-end review, the Swiss National Bank said itsreduction of dollar assets has improved its risk-return profile.

One example of a poorly compensated risk, from the

point of view of a Swiss franc investor, is the U.S. dollar cur-rency risk on bonds, the bank wrote. Our experience hasbeen that expected earnings on bonds in other currencies,such as euros or sterling, are comparable, while currencyrisks are significantly lower. Consequently, and alsobecause another important reserve currency was availablein the form of the euro, we have substantially reduced ourshare of U.S.-dollar investments over the past few years.

As central banks go, the Swiss National Bank is probably

highest on the list for the reserve-management function,and its reduction of dollars, embrace of gold, and diversifi-cation to equities is not going unnoticed in the petrodollarcountries and Far East. Like the Swiss, the Chinese arealready contemplating a special-purpose agency to divertsome of its massive reserves into an actively managed fundthat would seek higher returns.

Such a fund could contain equities, real estate, stockpilesof oil and other commodities anything. If the special-purpose agency invested in non-liquid assets, they proba-bly wouldnt qualify as reserves anymore. The purposeof foreign exchange reserves is to have enough money to

buy food and energy for several months in the event of acatastrophe. If you have already stockpiled food and ener-gy sources, arent you achieving the same purpose withoutthe currency risk?

Issue of the year?In 2007, reserve diversification is going to be the dominanttheme in the forex market, and because Japan and Chinahold the highest reserve amounts, they are the countries towatch.

Japan is unlikely to change its reserve composition much,if at all, for the simple reason it is a nation with no defensecapability that relies on the U.S. for its external defense.

ON THE MONEY

Reserve diversification,

Part IIWhile some countries have already reduced their U.S. dollar-based currency reserves,

a similar decision by the Chinese government would be bad news for the greenback. That threat will

likely hover over the market in 2007, and the U.S. government is doing what it can to prevent it.

BY BARBARA ROCKEFELLER

In 2007, reserve diversification is

going to be the dominant theme

in the FX market



As for China, whats the probability of a one-time sale ofa large chunk of dollar assets? Its not zero, even thoughsuch a sale would drive down the value of the remaining

assets and also the value of trade payments in the works.This is the golden goose argument. The Chinese know

if they take actions that result in the devaluation of their bestexport customers currency, their trade surpluses will fall.Last year that surplus was $102 billion and its on track toexceed that this year, (possibly reaching $168 billion). Chinafavors export industries that provide factory jobs for tens ofmillions of workers, not to mention the millions more flock-ing from the countryside to cities looking for factory jobs.

On the U.S. accounts, the reckoning looks a little differ-ent. The U.S. deficit cant be attributed entirely to China, ofcourse, but its a big piece of it 41 percent ($24.37 billion)

during November, for example. Through November, thetotal deficit with China was $190.63 billion, meaning thisyear will almost certainly surpass last years deficit of$201.66 billion. How can China have a total surplus of $102billion when its surplus with the U.S. is $202 billion? Easy its spending some of the surplus outside the U.S.

Whether we are talking about Chinas $100-billion sur-plus or the U.S.s $200-billion deficit with China, the numbers are too big by anyones reckoning, and the risingtrend is bothersome because it points directly to bad pricingin currencies.

This is hardly a secret. In August 2005, China revalued its

currency (the yuan) by a little more than 2 percent in oneday and moved to a series of smaller daily moves that as ofmid-December 2006 added up to less than 5.5 percent total.This is a mere drop in the bucket and inspires virtually nochange in the trade dynamics. How much should Chinarevalue to equilibrate trade?

Estimates range from a modest (and achievable) 10-15percent to a more commonly quoted 35 percent. Last year,U.S. Senators Schumer and Graham came up with a need-ed yuan appreciation of 27.5 percent. Thats the amount ofthe tariff on Chinese goods they proposed then withdrewunder pressure and promises from the Treasury Secretary.

Talking things out

To clean up relations with China, the U.S. started out with abang a top-level meeting between U.S. and Chinese offi-cials under the auspices of a Chinese state-sponsoredresearch institute in Beijing chaired by Vice-Premier Wu Yi.Representing the U.S. was Treasury Secretary HankPaulson, accompanied by Fed Chairman Ben Bernanke andseveral high-level administration officials, includingSecretary of Commerce Carlos Gutierrez, Labor SecretaryElaine Chao, Energy Secretary Samuel Bodman, and Healthand Human Services Secretary Michael Leavitt, plus U.S.Trade Representative Susan Schwab and Environmental

Protection Administration chief Stephen Johnson.Even in the 70s and 80s, when the U.S. was pressuring

Japan on trade issues, the U.S. did not delegate so many

cabinet-level officials to a single meeting. In other words,the summit was a very big deal, even though it lasted onlytwo days (Dec. 14 and 15).

Ahead of the meeting, Paulson tried to manage expecta-tions downward, saying the gathering was only the start ofa strategic economic dialogue that would go forwardwith another big meeting in May 2007 in Washington.

The reserve diversification issue is not publicly on thetable, but its the 800-pound gorilla in the room. Officially,the U.S. has three concerns correcting the trade imbal-

ance that is partly because of the mispriced yuan, openingup the financial market to competition and thus free-market

pricing that will avert a financial collapse at some pointdown the road, and ending various unfair practices, such ascopyright infringement and piracy.

In fact, just before the delegations trip to China, the officeof the U.S. Trade Representative prepared a 100-page reporton Chinas violation of generally accepted practices underWorld Trade Organization (WTO) principles. The reportnames three areas of concern: copyright piracy, subsidies ofexport companies, and failure to open the economy to foreigncompetition, as China agreed to do when it joined the WTO.

After the meeting, Paulson said everyone agreed in prin-ciple on the major issues the only thing missing was

agreement on the timing. This is not strictly true. TheChinese asked the U.S. to promise it would take action toboost U.S. savings. Paulson declined to make the promise,although he said the U.S. government will start working onit. Nonetheless, the timing issue is plenty big enough tobring the tentative agreement crashing down and get theChinese talking about reserve diversification.

This would be counterproductive from the Chinese pointof view, but not everything in diplomacy has to be in ones best financial interests. Its not inconceivable that Chinacould diversify just to show that it doesnt like being bul-lied, especially within the WTO. China viewed being

continued on p. 16

The reserve diversification issue maynot be on the table publicly, but its

nonetheless the 800-pound gorilla

in the room.



ON THE MONEY continued

accepted as a member of the WTO as tantamount to beingaccepted in the Big Boys Club. Right after China joined theWTO, the Group of Seven (G7) started inviting China to itsmeetings as a guest. To be the subject of an adverse action

at the WTO, let alone a ruling, would be to lose face.The summit failed to achieve specific goals. The U.S.

wants a faster currency revaluation from China than 6 per-

cent over 18 months, although its not known what number,if any, the U.S. proposed. The Chinese commit only to thestatement they will accelerate reform. This is too vague tomean anything, and it prolongs the waiting game.

Meanwhile, Trade Representative Schwab talked toughahead of the summit and afterwards, too, saying the U.S.has prepared several actions to present to the WTO. Its notclear whether the summit changed the timing of theseactions. If the U.S. removed WTO actions as a quid pro quofor faster revaluation, it would mean the U.S. was choosingto disregard the law, which makes it look unprincipledand venal. After all, the rule of law is supposed to be thebedrock of Anglo-American civil society.

Technically, the law in this case is the WTO agreement,which is a treaty. The treaty gives the organization thechoice to seek a judgment against unfair trade practices by

other signatories, but it does not oblige the WTO to do so.

The obligation part comes from the nature of democracy,which trusts that a government will serve the best interestsof its citizens.

Regardless, the U.S. is likely to trade some of the WTOissues for progress on financial market reform and Chinaspending more money in the U.S. One day after the sum-mit, China announced that Westinghouse would undertakea vast nuclear energy project in China. Although its owned by Toshiba, Westinghouse is headquartered in Pittsburgh,and the U.S. part of the deal will be worth $3 to $4 billion.

Energy Secretary Bodman said the deal would create5,500 jobs in the U.S. Separately, but not coincidentally, the

six-party talks on North Koreas nuclear plans resumed inBeijing after being stalled for more than a year. North Koreais Chinas client state (albeit a troublesome one), and theU.S. is counting on China to rein in Pyongyang after itthreatened Japan (the U.S. client state) in recent months.

High stakesAs for financial market reform, the situation in China isvery high-risk. As Fed Chairman Bernanke said in hiskeynote speech, opening the financial market to western-style competition and free-market pricing is in Chinas bestinterests: It will prevent the financial collapse that is almostcertainly brewing.

Specific risk factors such as tariffs,

WTO cases, and special Chinese

reserve-management agency action

will provide trading opportunities.

Related reading

Recent Barbara Rockefeller articles:

Charts are not enough

Currency Trader, December 2006.

Breaking down price action in light of the news.

When will the yen go to the moon?

Currency Trader, October 2006.

The fundamentals are all pointing toward an up move in

the Japanese yen. So whats it waiting for?

Why is everybody losing money in forex?

Currency Trader, September 2006.

Despite unprecedented liquidity, professional currency

managers have had a rough go of it in 2005 and 2006.

Has something changed in the forex world?

Gauging trader commitment

Currency Trader,August 2006.

Is this a good breakout or a false move? The

Commitment of Traders report can help currency

traders fill in some of the holes left by the absence of

traditional volume data in forex.

Trading pullbacks in foreign exchange

Currency Trader, July 2006.

Discover some new ideas including the Tuesday

pullback for trading corrections in the currency

market.

Barbara Rockefeller Big Picture Collection,

Vol. 1: 2004-2005.

This 11-article collection contains forex market analysis

and commentary Barbara Rockefeller wrote for

Currency Traderbetween October 2004 and December

2005, available at a 30-percent discount.

You can purchase and download past articles at

www.activetradermag.com/purchase_articles.htm.
http://www.activetradermag.com/purchase_articles.htmhttp://www.activetradermag.com/purchase_articles.htm



Chinese banks pay about 2 percent for deposits andcharge about 6 percent for loans, which is a nice spread onlyif the loan recipients are credit-worthy. In far too manycases, they are not they are inefficient and corrupt gov-

ernment entities that economically do not deserve the pro-tection of the state. Bernanke deserves credit for coura-geously calling a spade a spade.

Its not going without notice, however, that the leader ofthe financial reform cheerleading team, Mr. Paulson, has apotential conflict of interest. As chairman of GoldmanSachs, he has made 70 trips to China since 1991 developingbusiness for the firm. This included the ill-fated effort of thegovernment-owned China National Offshore OilCorporation to acquire Unocal in 2005, a takeover that wasultimately opposed by Congress.

One Goldman Sachs-sponsored deal was underwriting

the initial public offering of the Bank of China, a $9.7 billiondeal. According to Frank Gaffney in the National Review,Among other problematic activities the Bank has engagedin has been the financing over the past 15 years of extensiveinfrastructure projects like dam-building for themullahocracy in Iran.

It might be nave to think that anyone who hasalready amassed a personal fortune estimated atsome $600 million is above seeking additionalpersonal gain after taking office as a public ser-vant. But even if Paulson has the best interests ofthe American public at heart, what is the U.S.s

best interest when its banks are in bed withChinese banks? Bankers have influenced foreignaffairs for years. Ford and General Motors wereactive in Nazi Germany. Its a nasty and danger-ous game.

Goodwill not enough

China has demonstrated goodwill in the form ofthe Westinghouse deal, resumption of the six-party talks with North Korea, promises of curren-cy appreciation acceleration, and praise for all thehomework done by the U.S. ahead of the summit.

Goodwill is not enough, though.China will probably not revalue fast enough toplease the U.S. Congress, which will retaliatewith tariff and other trade-restraint bills. Thesemay not pass, and if they do they may be vetoedby the President, but the rhetoric will poison theU.S.-China relationship.

The Office of the Trade Representative will,with regret, lodge its complaints with the WTO.China will probably establish its special-purposereserve management fund along the lines of theSwiss agency, and diversify out of dollar assets orat least out of U.S. government bonds and

Agency obligations. It is Paulsons job to keep the financialwar at a simmer and not on a boil, but he faces a nearlyimpossible task. Loud and angry words are on the horizon.

This scenario is the mainstream forecast for the upcoming

year, and many think theres a better than 50-50 chance of itactually occurring. As traders, we can easily make the mis-take of attributing big-picture macro developments such asthese to the immediate trading environment. That doesntalways work.

However, the reserve diversification story is getting ripenow that the U.S.-China summit is over without hard andspecific promises on both sides. Watch the news, not only forthe pace of yuan appreciation but also the specific risk factors tariffs, WTO cases, special Chinese reserve-managementagency action that will provide trading opportunities.

Because market sentiment is profoundly dollar-negative,

good news on these issues will not necessarily boost thedollar, but bad news will certainly harm it.

For information on the author see p. 6.
http://www.tradeguider.com/http://www.tradeguider.com/smartmoney/factsheet



Unlike major industrialized currency portfo-lios, many emerging market assets madesignificant gains over the course of the pastyear, with some funds producing returns as

high as 200 percent.With managers increasing their investment into countries

as far flung as Singapore and South Africa, a new demand

has surfaced for regional currencies. This trend hasopened a new world of trading in currency pairs involvingthe South African rand (ZAR), Singapore dollar (SGD),Hong Kong dollar (HKD), Mexican peso (MXN), and eventhe Norwegian krone (NOK). Once strictly reserved forinstitutional participants, these currencies are now avail-able to retail traders.

However, although they have manysimilarities to the major currency

pairs, emerging-market pairs (EM)have some unique characteristics andconsiderations which potential tradersshould understand before attemptingto trade them.

Similarities

Despite their singular personalities,from a technical perspective emergingmarket currency pairs trade similarlyto major G7 currency pairs. Figure 1shows a daily chart of the U.S. dol-

lar/S. African rand (USD/ZAR) pair.Also, fundamental market drivers,including central bank actions, are rel-atively comparable. So, experiencedtraders can essentially transfer theirG7 currency trading experience intothe emerging-market area.

For example, shifts in the MXN orZAR can happen on speculation ofrate hikes by the central banks inMexico and South Africa. Retail salesis a key report in Hong Kong and

ON THE MONEY

Emerging market currencies:A new FX dimension

South Africa, Singapore, Mexico, and Hong Kong are just some of the countries whose currencies

have moved beyond the institutional club and are now available for individual trading.

BY RICHARD LEE

Emerging market currency pairs trade similarly to major G7 currency pairs froma technical perspective, and fundamental market drivers, including central bank

actions, are relatively comparable. The main differences between these markets

and the major currency pairs are liquidity and a lack of transparency in related

economic data.

FIGURE 1 U.S. DOLLAR/SOUTH AFRICAN RAND

Source: FX Trek Intellicharts



Singapore because these countries economies are increas-ingly dependent on exports and domestic spending by theircitizens.

A word of caution, however, about these reports: Becauseof the lack of transparency in many EM governments andofficial agencies, reports tend to be slightly understated oroverstated. Also, many EMeconomies are based on a singlegrowth sector e.g., non-oil domes-tic imports in Singapore which canresult in wide swings from month tomonth.

Differences

Other, more practical, differences exist between emerging market currenciesand their G7 currency counterparts.One thing to take into consideration isa currency pairs peak trading hours.Although the major currency pairs areprimarily traded in the European andearly New York sessions, emergingmarket currency pairs have more frag-mented and specific prime trading

periods.For example, because of its

London ties, the South African randtends to trade most heavily duringthe London-session hours, as well asthe early New York session (Table 1).The rand has a whopping 871-point(pip) average daily range similarto the British pound (GBP), whichonce had a heavy influence in thecountry.

The Hong Kong dollar, by compar-

ison, has no preferred trading time because the currencysvalue is restricted within certain boundaries set by theChinese monetary authority. As a result, throughout theentire 24-hour forex trading session, the HKD will rise andfall, generally in a well-mannered and gradual fashion,

continued on p. 20

This table shows the average daily ranges and most active trading periods in some of the emerging-market currency pairs

during the three years ending November 2006.

TABLE 1 DIFFERENT TIMES DOMINATE DIFFERENT CURRENCY PAIRS

Currency Symbol Average daily range Most active trading period (ET)

U.S. dollar/South African rand USD/ZAR 871 pips 2 a.m. to 12 p.m.

U.S. dollar/Hong Kong dollar USD/HKD 25 pips

U.S. dollar/Singapore dollar USD/SGD 53 pips 3 a.m. to 12 p.m.

6 p.m. to 12 a.m.

U.S. dollar/Mexican peso USD/MXN 546 pips 7 a.m. to 3 p.m.

Source: FXCM LLC
http://www.buysellorgetout.com/




within a narrow 25-pip range (Figure 2). This kind ofmovement will likely suit more conservative traders with

lower risk tolerance and smaller account sizes.By comparison, the more volatile Mexican peso has a 546-

pip average daily pace (Figure 3), making it more appropri-ate for experienced traders who are comfortable with high-er risk; smaller traders can easily find themselves in a mar-

gin-call situation. (The assumption here is that the pairs are being traded on an equal, per-lot basis. However, thiswould differ if you increased your position in the HongKong dollar by, say, 20 lots, or decreased your position pro-portionally in the Mexican Peso. As a result, traders shouldalways be mindful of how different currencies trade, as wellas the size of their positions.)

Oddly enough, the Singapore dollar (Figure 4) has twodistinct trading periods, as two different markets in the cur-rency begin in the 24-hour forex session. Starting with theEuropean market, the SGD experiences higher volume andvolatility from 3 a.m. to 12 p.m. ET. This is mainly because

markets in both London and New York are actively tradingin the currency pair.

The USD/SGD pair tends to lay lowduring the U.S. afternoon session, onlyto pick up again when Asian markets begin trading. With traders in HongKong and Japan at their desks, volume begins to increase for the six hoursfrom 6 p.m. to 12 a.m. ET. During this

time the pair will tend to make movesthat can be considered a mixture of thetwo markets. Generally, theUSD/SGDs moves are not as wide asthe Mexican pesos, but not as narrowas the Hong Kong dollars. The aver-age range is around 53 pips, which iscomparable to most G7 major currencypairs.

The liquidity question

A key consideration in EM currency

trading is liquidity. Most major indus-trialized currencies are relatively liq-uid, but emerging market currenciesare often thinly traded, especiallyaway from peak-trading hours. In fact,illiquidity is often seen as the cause ofvolatility in pairs such as the

dollar/rand and dollar/peso. (Or is it the other way around does volatility in the pair create illiquidity?)

The reduced number of market participants active inthese currencies affects the smoothness with which theytrade. With market makers offering liquidity during only

the most active periods, prices and spreads tend to besomewhat hit or miss even for upper-echelon bank andinstitutional traders during off-peak hours.

This can be problematic for traders used to the high (andrelatively consistent) liquidity of G7 currency pairs.Nonetheless, for experienced traders, this is simply anotherconsideration to be weighed in light of the reward that maybe available in the emerging currencies.

Whats ahead

With new political developments and economic policiesforming in certain emerging markets, the near-term futures

Because of the currency restrictions in China, the Hong Kong dollar generally

fluctuates in a well-defined range, which may be attractive to more conservative

traders.

FIGURE 2 U.S. DOLLAR/HONG KONG DOLLAR



21/53

of these currency pairs should be very interesting.Singapore. Although economic growth in Singapore

slowed in 2006 after peaking at 10.8 percent in the firstquarter, expansion in Southeast Asias fourth-largest econo-my nonetheless grew at a higher-than-expected 7.1 percentin the third quarter.

Manufacturing has been a major con-tributor to Singapores economicexpansion; demand for the countrys

products has led to booming exportgrowth, accounting for nearly a quarterof Singapores $118 billion economy.This strength has helped drive theunemployment rate down to 2.7 per-cent. As a result, wages have edgedhigh enough to potentially improveconsumer spending, which hasdeclined in five of the past eight monthsas of December 2006.

Another major source ofSingaporean economic strength is an

influx of Asian investors. Singaporesfinancial regulations are generally lesscumbersome than those in other Asiancountries, such as Japan. For example,according to an annual survey byKPMG, Japans corporate tax rate is40.7 percent, more than doubleSingapores 20 percent rate, whichreduces operating costs and boostscorporate profit margins.

Given the vitality of the economy,the Monetary Authority of Singapore (MAS) surprised no

one in maintaining its SGD hawkish bias at its semiannualreview in April and October of this year. This means policymakers will keep a relatively watchful eye on the economyand its currency as inflationary pressures rise. They willlikely make near-term adjustments to the SGDs peggedband. Although definitively unknown, the band on averagehas fluctuated between +/- 0.03 percent and +/- 0.06 per-cent of the current rate dictated at the semiannual reviews.Central bankers will opt to adjust the currencys bandthrough monetary intervention (rather than by adjusting abenchmark interest rate) to quash speculation in the market.

Subsequently, the bias will remain a mainstay until funda-

mentals shift and policy makers alter their views at a fol-lowing review.

Hong Kong. Sluggish growth in global exports could con-tinue to plague economic expansion in Hong Kong. In thesecond quarter of 2006, the Hong Kong economy grew 5.2percent from Q2 a year earlier, with exports gaining 6.4 per-

cent the smallest increase in four years after jumping

14.4 percent in Q1.Nonetheless, Q3 GDP is expected to accelerate to 5.8 per-

cent, as private consumption may be able pick up the slack.Households have started to spend more as the jobless ratedropped to a five-year low of 4.5 percent in the third quar-ter and the benchmark stock index, the Hang Seng, made anew all-time high during the same period.

As the economy expands, labor demand is increasing andcompanies have added workers to cope with increasingbusiness. This has resulted in more competition for skilledtalent, boosting employee incomes and leaving people with

With a 546-pip average daily range, the Mexican peso is one of the morevolatile emerging market currencies, making it more appropriate for experienced

traders who are comfortable with higher risk.

FIGURE 3 U.S. DOLLAR/MEXICAN PESO


continued on p. 22

CURRENCY TRADER January 2007 21


22/53

more money to spend. Meanwhile, the

same rising corporate earnings thatare paying for more workers will alsounderpin investment expenditures.

Consumer prices in Hong Kong onlyemerged from deflation two years ago.However, the economic reboundpushed up rents in the city, and thisinflationary pressure has spread toother areas, including clothing andfood. Hong Kongs consumer priceindex (CPI) reached an eight-year high

of 2.5 percent in August. Althoughinflation eased slightly to 2.1 percent inSeptember (because of shifts in volatilefresh food and oil prices), the HongKong Monetary Authority still antici-pates inflation will accelerate to 2 per-


The USD/SGD pair has an average daily range of around 53 pips, which is

comparable to most G7 major currency pairs.

FIGURE 4 U.S. DOLLAR/SINGAPORE DOLLAR

http://www.optionstradermag.com/



cent this year from 1 percent in 2005.

South Africa. In what might be con-sidered a paradox, consumer spendinghas become the thorn in the side of theSouth African economy. Retail salesare driving economic growth, rising8.7 percent in August and pushingGDP to 4.9 percent in the second quar-ter of 2006.

Although this would be seen as anencouraging sign of growth in manycountries, in South Africa consump-

tion has led to a record current accountdeficit. The current account balance hitan all-time low of -103.14 billion randin Q1, and while the deficit narrowedto 101.67 billion rand in Q2, at 6.1 per-cent of GDP the figure is still a far cryfrom being remotely balanced.

The primary concern is the govern-ment will struggle to attract the for-eign investment needed to finance thisdeficit, which has caused the rand todrop more than 20 percent against the

dollar since May 1. The surge inspending and a weaker rand have alsofueled inflation, which jumped to athree-year high of 5.1 percent inSeptember. The South African ReserveBank (SARB) has tried to discourageexcessive consumer spending onimports and curb price pressures byhiking rates three times since June2006 (to a three-year high of 8.50 per-cent). Nonetheless, the SARB forecastsCPI to hit the top of the 3-6 percent tar-

get range in 2007.Also, the central bank may not be

done with monetary policy tighteningyet, as credit growth has continued tosurge. Higher interest rates have yet todiscourage borrowers, and consumerdebt hit a record 69.8 percent of dis-posable income in Q2.

Mexico. Growth in Mexico, which islargely dependent on export demandfrom the U.S., could continue to slowafter peaking at a five-and-a-half year

high of 5.5 percent in Q1 2006. The

countrys GDP slipped to 4.7 percentin Q2, but the figure was still encour-aging as consumption, investment,and external demand performed well.Mexicos expansion was mainly theresult of the boom in oil, its biggestexport, as prices rose to record highsand growth in the U.S. fueled demandfor Mexican manufactured goods,such as cars. However, with Q3 GDPin the U.S. falling to a tepid 1.6 percent,

growth in Mexico could be endan-gered in coming months as well.The main determinant of future per-

formance is likely to be the politicalenvironment. In the aftermath of a bit-terly contested election, president-electFelipe Calderon plans to adjust manyaspects of the economy. Calderonspredecessor Vincente Fox was knownto concede to labor unions to ensureeconomic and social stability, butCalderon has indicated he will take a

different route. His plans include majorreforms to the state oil and electricitycompanies, public school systems, andthe labor code. Unions are expected tooppose efforts to adjust labor law,much of which dates back to the 30sand has been a major deterrent to for-eign investment and job creation.Additionally, Calderon is under pres-sure to generate more tax revenue toincrease the governments credit rat-ing, which Moodys currently rates at

level Baa1, the third-to-lowest invest-ment grade category.

As a result, Calderon has vowed tointroduce a flat-tax for corporations, achange that will simplify the tax codeand encourage more people to paytaxes. While major reforms would cre-ate instability in the short-term, thelong-range outlook for the economywould improve by leaps and bounds, agood sign for the Mexican peso.

New markets,

new opportunities

Acknowledging the differences betweenemerging-market currencies and their better-known G7 counterparts, thesemarkets offer plenty of opportunities formore experienced traders. Traders mustbe realistic about the different dynamicsin these currencies the frequentabsence of fundamental transparencyand liquidity issues.

However, with an understanding of

these challenges firmly in place, retailinvestors and traders should havegreater opportunity to diversify in anew sector of the forex market.


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In the latter part of 2006, the U.S. dollar/Canadiandollar (USD/CAD) pair staged one of its bigger upmoves within the massive downtrend that has dom-inated this currency pair since the beginning of 2002.

After hitting a low of 1.0927 in May, dollar/Canada closedhigher every month but August, rallying above 1.1500 byDecember its highest level in eight months. October,November, and December were, in fact, the first three con-

secutive months of higher highs, higher lows, and highercloses since Oct. 31, 2001.

Thats the big picture. To understand how this currencypair trades from day to day, the following study first breaksdown the USD/CAD rates daily behavior from Dec. 1, 2005to Nov. 30, 2006 (a total of 261 trading days), detailing thedaily ranges, close-to-close changes, typical lows for daysthat close up, and typical highs for days that close down.

Then, additional intraday analysiswill explore this markets performance

on an hourly basis from Oct. 1, 2006through Nov. 30, 2006, highlightingwhen the most volatility occurs duringthe 24-hour trading session.

As a whole, this information pro-vides insight into the typical pricebehavior in the USD/CAD rate, whichallows traders to make trading deci-sions and design strategies based moreon science and less on emotion orguesswork.

Daily range statisticsFigure 1 is a daily bar chart of thereview period. The market tradedfrom a high of 1.1800 in January 2006to below 1.1000 in May and June 2006.The most notable price move duringthe study period was the sharp April-May downtrend.

Figure 2 sorts the daily ranges fromlowest to highest. The smallest range,0.0033 points, occurred on April 14,

2006; the largest range, 0.0191 points,

TRADING STRATEGIES

Dollar/Canada

by the numbersAs the only purely North American major currency pair, the dollar-Canada rate occupies a unique

position. We break down its short-term performance to reveal daily and intraday tendencies.

FIGURE 1 DAILY USD/CAD

Source: CQGNet (www.cqg.com)

The dollar-Canada pair made only one significant run during the analysis period

the down move from April to the end of May.

BY THOM HARTLE
http://www.cqg.com/http://www.cqg.com/



occurred on May 9, 2006. The average

range was 0.0085 points and themedian was 0.0080 points, whichimplies a few large outliers pushedthe average value above the median(notice the six extreme daily ranges atthe far right of the chart).

Figure 3 shows the distribution ofthe daily ranges. The vertical barsshow how many daily ranges therewere in each size category. For exam-ple, the bar labeled 0.0080 (the fifth

one from the left) shows how manydaily ranges were larger than 0.0070points up to and including 0.0080points. In this case, there were 30.

Sixty-eight percent of the dailyranges were larger than 0.0060, up toand including 0.0100 points. The sixranges that were larger than 0.0180points up pulled the average abovethe median.

Close-to-close changes

Analyzing the typical close-to-close behavior revealed the market closedunchanged just three times. Thelargest close-to-close loss was -0.0170points and the largest close-to-closegain was +0.0139. Figure 4 shows thedistribution for all the close-to-closedifferences. Eighty-seven percent ofthe close-to-close differences were between +0.0070 and -0.0070 points,and the single highest number ofclose-to-close moves were between

-0.0020 and -0.0030 points (the -0.0020 bar). The close-to-close changeexceeded +0.0100 or -0.100 only fivepercent of the time.

During the review period, the mar-ket closed up 122 days (47 percent ofthe time). In Figure 5, up-closing daysare plotted to highlight each daysprice movement relative to the previ-ous days close: The bars are adjustedso that the previous days close is

FIGURE 3 DAILY RANGE DISTRIBUTION

The majority (68 percent) of daily ranges were greater than 0.0060 points up to

and including 0.0100 points.

Currency characteristics: USD/CAD

Some insights from Dec. 1, 2005 through Nov. 30, 2006:

1. The average range was 0.0085 points. The range exceeded 0.0130

points only eight percent of the time. Sixty-eight percent were above

0.0060 and up to 0.0100 points.

2. The close-to-close changes exceeded +0.0100 or -0.100 five percent

of the time.

3. If the pair traded more than 0.0050 points below the previous days

close, it had only a 6-percent chance of closing up for the day.

4. If the pair traded 0.0050 points above the previous days high, it had

only an eight-percent chance of closing down for the day.

5. Intraday analysis from Oct. 1, 2005 through Nov. 30, 2006 shows the

highest average range for the 60-minute bars occurred during the

7:00 hour. Here, the average was 0.0028 points and the median was

0.0027 points.continued on p. 26

FIGURE 2 DAILY RANGES

The median daily range was 0.0081, the smallest range was 0.0033, and the

largest was 0.0191.



TRADING STRATEGIES continued

zero and the bars high and low arerelative to the zero line. Most of thelows are no more than 0.0025 points below the previous close before themarket rallied to close higher.

Figure 6 shows the distribution oflows on days the market closed inpositive territory. The low was abovethe previous days close only onetime during the analysis period.

Eighty percent of the time the lowwas no more than -0.0025 pointsbelow the previous days close. In 40of the 122 up-closing days (33 per-cent), the market traded between-0.0010 and -0.0020 below the previ-ous close. Price dropped below theprevious days close by more than-0.0050 points and recovered to closehigher only six percent of the time.

The pair never recovered to closehigher after being down 0.0075 pointsdown on the day.

Figure 7 is similar to Figure 5except it shows days the USD/CADpair closed down. Again, the bars areadjusted relative to the previousdays close. Two days were up nearly0.0100 points but reversed to closelower, but most of the days werenever up more than 0.0050.

Figure 8 shows the distribution of

the highs for down-closing days. Thecurrency pair closed in negative terri-tory 135 times during the review peri-od. The high was the same as the pre-vious close two times, but it wasnever below the previous close.

The range for highs on down-clos-ing days was wider than the range forlows on up-closing days. The twooccurrences represented by the barlabeled 0.0095 were the two highsnoted in Figure 7, where the market

FIGURE 5 UP-CLOSING BARS RELATIVE TO PREVIOUS CLOSE

When the USD/CAD rate closes up on the day, price usually does not drop more

than 0.0025 points below the previous close.

FIGURE 4 DAILY CLOSE-TO-CLOSE CHANGES

Most of the daily close-to-close moves were between +/-0.0070 points.

If the pair traded 0.0050 points above the previous

days high, it had only an eight-percent chance of

closing down for the day.


27/53

traded as high as 0.0092 points abovethe previous close but still closeddown on the day.

The high for down-closing dayswas between 0.0005 and 0.0035 points79 percent of the time. If the pair trad-ed 0.0050 points above the previousdays high, it had only an eight-per-cent chance of closing down for theday.

Next, we move down to the hourlytime frame to analyze the pairs evenshorter-term tendencies.

Intraday price behavior

The intraday analysis data used 60-minute price bars and a 24-hour clockbased upon Central Time. On Fridays,the market closes at 15:00 (3 p.m.) andreopens at 16:00 (4:00 p.m.) on

Sunday. On other days, it closes at23:59 (11:59 p.m.) and reopens at 0:00(midnight).

Figures 9A-9C are 60-minute chartsspanning the Oct. 1 through Nov. 30,2006 intraday analysis period. On thistime frame the market manifestednoticeable trends, choppy tradingranges, and spike reversals.

To determine whether there is anyconsistent time of day price tends totrend, the high-low range for each 60-

minute bar was calculated and sortedby each hour. Next, both the averageand the median were determined foreach period. (The median is includedbecause it represents the center pointof each bar; if the average is notablydifferent from the median, then out-liers are skewing the data.

Figure 10 shows the average andmedian of the 60-minute bars sorted by hour. The highest average range

continued on p. 28

FIGURE 6 DISTRIBUTION OF LOWS ON UP-CLOSING DAYS

On days the market closes higher, the low is usually no more than 0.0025

points below the previous close.

FIGURE 7 DOWN-CLOSING BARS RELATIVE TO PREVIOUS CLOSE

Down-closing days are shown here relative to the previous days closing price.

FIGURE 8 FREQUENCY DISTRIBUTION OF HIGHS

FOR DOWN-CLOSING SESSIONS

On down-closing days, the high was less than 0.0035 points above the previous

days close 79 percent of the time. During the analysis period, the USD/CAD

pair never failed to at least match the previous sessions close.



28/53

TRADING STRATEGIES continued

for the 60-minute bars occurredduring the 7:00 hour (7 to 8 a.m.CT). The average was 0.0028points and the median was0.0027 points. The next-highestaverage range was the 9:00 hour,with an average range of 0.0026points and a median range of0.0025 points. During the 8:00

hour, the average range was0.0025 points and the medianrange was 0.0023 points. Theprice movement tapers off from16:00 on.

Figure 11 shows the individualranges for the three high-volatili-ty hours. Interestingly, eventhough the 7:00 hour had thehighest statistics, the only twohourly ranges larger than 0.0050points occurred in the 8:00 and

9:00 hours. However, the 7:00period has a higher number ofwider-range bars relative to theother two periods.

Figure 12 shows the distribu-tion of the hourly ranges duringthe 7:00, 8:00, and 9:00 hours.Most of the ranges are in theneighborhood of 0.0020 up to0.0030 points, which is greaterthan the average hourly range formost of the other periods.

Currency Characteristicssummarizes some of the high-lights from this analysis of theUSD/CAD pair.

Using the data

This type of research is useful forseveral reasons. First, all marketshave tendencies; taking the timeto document them allows you todevelop trading approaches based on hard data rather than

FIGURE 9 INTRADAY PRICE ACTION

Source: CQGNet (www.cqg.com)

On the hourly time frame, the USD/CAD rate displays both trending and non-trending

phases, as well as sharp reversals.




visual chart inspection or gut feel.You can work with probabilitiesregarding the markets price actiontoday and tomorrow.

Also, this type of analysis is easilyexpandable to larger time horizonsand different tendencies. For exam-ple, you can find out what happens (ifanything) the day after back-to-back

up-closing days with ranges largerthan 90 percent of all ranges.Finally, having typical-behavior

stats in hand will allow you to quick-ly spot when a shift in a marketsunderlying fundamentals is takingplace.


For more information about theUSD/CAD rate, see The death knell for

Canadian bulls?

The two peak readings occur in the 8:00 and 9:00 hour, but the 7:00 hour has

more wider-range bars.

FIGURE 10 60-MINUTE BAR RANGES SORTED BY HOUR

The most price movement occurred in three bars the 7, 8, and 9 a.m. bars.

FIGURE 12 DISTRIBUTION OF THE 7 TO 10 A.M. RANGES

The majority (60 percent) of the ranges were between 0.0020 and 0.0030

points.

FIGURE 11 THE 7 TO 10 A.M. HOURS

Related reading

Euro/yen: Tips and tendencies


Euro/yen by the numbers: Stats

and tendencies for short-term forex

players.

Breaking down the euro

Currency Trader, November 2006.

Studying the euros daily and intra-

day performance statistics offers

guidelines for systematic and

discretionary traders.

You can purchase and

download articles at

www.activetradermag.com/

purchase_articles.htm
http://www.activetradermag.com/purchase_articles.htmhttp://www.activetradermag.com/purchase_articles.htmhttp://www.activetradermag.com/purchase_articles.htmhttp://www.activetradermag.com/purchase_articles.htm



Adownside of being in the trading business(including the analysis of economic andfinancial history) for any length of time is theconstant reminder of human foibles. Given

this author has described the entire history of currencies(going back to the original barter standard) as the financialversion of Original Sin, we should be able to take any long-dated currency market, look back, and weep.

Another downside, as long as were at it, is how little theworlds governments care about market analysts. Theyhave constantly changed parameters, re-based economic

time series, added and dropped data reports and in thegranddaddy of all indignities created the euro. Not thatthey had much choice in the last matter: The two decades between the adoption of flexible exchange rates with theSmithsonian Agreement in March 1973 and the adoption ofthe Maastricht Agreement in February 1992 were character-ized by one currency crisis after another in Europe.

The use of multiple currencies within a tightly-linkedeconomic zone with widely disparate politics and cultureswas an insoluble problem. At best, attempts to maintaincurrencies within a band involved wildly swinging short-

term interest rates as nations sought todefend artificial exchange rates. Youcan fix an exchange rate, or you can fixinterest rates, but you cannot fix bothsimultaneously.

This certainly is visible in the longhistory of the cross between the Britishpound (GBP) and the Deutsche mark(DEM) and later the euro (EUR). Priorto 1992, the spread between the Bankof Englands (BOE) base lending rateand the Deutsche Bundesbanks dis-

count rate was volatile, to say theleast. It generally ranged between a 3-to 10-percent premium to the Britishside, but even this was insufficient toprevent a long slide in the GBP rela-tive to the DEM (Figure 1). The so-called Iron Cross fell from more than 6to a target level of 3, and this targetlevel of 3 DEM/GBP collapsed spec-tacularly in September 1992 whenGeorge Soros and others bet correctlythe British Exchequer would beunwilling to keep interest rates high

ADVANCED STRATEGIES

The newIRON CROSSMeet the new cross,

same as the old cross?

BY HOWARD L. SIMONS

The GBP steadily lost ground to the DEM despite the Bank of Englands

maintenance of high interest rates. The Iron Cross fell from more than 6

DEM/GBP to a target level of 3 which collapsed in September 1992 when

George Soros and other speculators correctly bet against the pound.

FIGURE 1 THE IRON CROSS, PAST AND VIRTUAL



enough to maintain the exchange rate.The Iron Cross eventually firmed as

part of the mid-90s pan-European con-vergence. Once the DEM was fixedinto the EUR in January 1999, the newIron Cross quieted into a narrow trad-ing range of roughly 2.75-3.00 almostwithout regard to the relative move-ment between the UK base lendingrate and the European marginal lend-ing rate, the successor to the old

Bundesbank discount rate.Once the EUR came into existence,

so did EURIBOR, the LIBOR rate for

the common currency. We can com-pare the forward curve for EURIBORwith Sterling LIBOR, a parallel con-struct for the GBP. As we have doneseveral times in these columns, we

will use the forward-rate ratio from sixto nine months (FRR6,9) as the metricfor monetary policy expectations. ThisFRR is the rate at which we can bor-row (for three months) starting sixmonths from now, divided by thenine-month rate. The more the FRRexceeds 1.00, the greater the expecteddegree of monetary ease.

The difference between the EURand GBP FRRs measures relativeexpected changes in monetary policy

continued on p. 32

Markets are discounting

devices: It is not the

current condition that

matters so much as the

expected condition.

The difference between the EUR and GBP FRRs measures relative expected

changes in monetary policy between the Eurozone and the UK. If the difference

is positive, the market expects future tightening in British monetary policy

relative to Eurozone monetary policy. If the difference is negative, the market

is expecting relative ease in British monetary policy.

FIGURE 2 RELATIVE MONETARY EXPECTATIONS

AND POUND-EURO CROSS

The rate spread between British and European 10-year notes was quite

narrow between 2000 and 2002, the period preceding the sharp weakening

of the British pound. When British yields started to rise relative to Euro yields,

the cross-rate stabilized.

FIGURE 3 BOND YIELDS AND POUND-EURO CROSS



ADVANCED STRATEGIES continued

(Figure 2). If the difference is positive,as it was during 2004-2006, the marketexpects future tightening in Britishmonetary policy relative to Eurozonemonetary policy. This relative tight-ness has helped maintain the GBP-EUR cross-rate in its tight range,much like the intentions of the pre-1992 BOE policies. If the oppositeholds, as it did throughout 2001, themarket is expecting relative ease in

British monetary policy. This ease pre-ceded a weakening in the GBP-EURcross-rate.

Markets are discounting devices: Itis not the instantaneous measure thatmatters so much as the expectedmeasure; no other explanation canexplain the tight range of the new IronCross.

A similar pattern is evident on thecapital market horizon. The ratespread between British and European

10-year notes was quite narrow between 2000 and 2002, the periodpreceding the sharp weakening of theGBP (Figure 3). Once British yieldsstarted to rise relative to Euro yields,the cross-rate stabilized.

Not created equal

The extent to which the Iron Crossdiffers from the British pound/U.S.dollar rate (GBP/USD) also can beshown in terms of the long-term inter-

est-rate history. Here, the seminalevent was neither the MaastrichtTreaty nor the creation of the euro, butrather the 1985 Plaza Accord, a con-certed agreement to weaken the USDin the vain hope such a move wouldcorrect the persistent U.S. currentaccount balance (Figure 4). Twodecades after the fact, to say thisagreement failed in this regard is agross understatement. It did, howev-er, succeed in creating violent movesin U.S. short-term interest rates and

The 1985 Plaza Accord was a misguided weakening of the USD designed to

correct the persistent U.S. current account balance.

FIGURE 4 INTEREST RATE DIFFERENTIALS HAD FAVORED DOLLAR

Volatility in the spread between the UK base lending rate and the U.S.

federal funds rate declined only after September 1992, when this spread

began leading changes in the GBP-USD exchange rate by six months, on

average.

FIGURE 5 THE BOE SELDOM LEADS THE FEDERAL RESERVE


33/53

helped precipitate the 1987 stock mar-ket crash, so in fairness it did achievesome results.

After the Plaza Accord, the GBProse sharply against the USD, butthere was no appreciable decline inrelative short-term interest-ratevolatility as measured by the spread between the UK base lending rateand the U.S. federal funds rate(Figure 5). That volatility declined

only after September 1992, when thisinterest-rate spread began leadingchanges in the GBP-USD exchangerate by six months on average.

The greater volatility of the UK base lending rate has led many toerroneously conclude the Bank ofEngland is some sort of stalking horsefor the Federal Reserve, just as theBank of Belgium often was for theBundesbank prior to the introductionof the EUR. Only twice after the Plaza

Accord, in June 1996 and again inFebruary 2004, did a BOE rate hikeprecede one by the Federal Reserve.The opposite is not quite as strong; aprolonged move in one direction bythe Federal Reserve often leads a sim-ilar directional move by the BOE. Thishas yet to happen after the FederalReserves long string of rate hikes in2004-2006.

Differential inflation

One of the reasons behind thesenumerous asymmetric and weak rela-tionships between monetary policiesand currency movements is the dif-ferent inflation rates in the U.S., UK,and Eurozone.

If we compare the American con-sumer price index (CPI), the Britishretail price index (RPI), and the Euroharmonized index of consumerprices (HICP can those bureau-crats in Brussels come up with catchy


continued on p. 34

Comparing the American consumer price index (CPI), the British retail price index

(RPI) and the Euro harmonized index of consumer prices (HICP) indicates the

British have the greatest endemic problem with inflation. British inflation has

exceeded the U.S. rate since 1975 and the HICP since its origin in 1996.

FIGURE 6 COMPARATIVE CONSUMER INFLATION

Since January 1999 British bonds have the highest total return because of

the reinvestment at the higher short-term rates notice the UK base lending

rate remains the highest of the three central bank rates.

FIGURE 7 MONETARY POLICY AND RELATIVE BOND RETURNS



names, or what?) over the past three decades (just onedecade for the HICP), we find the British have the greatestendemic problem with inflation (Figure 6). It has exceededthe U.S. rate since 1975 and the HICP since its origin in 1996.All else held equal, a higher inflation rate should lead toboth higher nominal interest rates and pressure for a weak-

er currency in their absence. This has been confirmed byhistoric experience.

Investors final word

Markets often produce counterintuitive results. We haveseen greater volatility in British monetary policy, higherBritish inflation and a currency seemingly dependent onhigher interest rates relative to both the USD and EUR forstability. Sounds like a good place to avoid, does it not?

No. If we take the total return for American, British, andEuro 10-year notes translated back to USD since January

1999, we find the British bonds have the highest total return.The reinvestment at the higher short-term rates note inFigure 7 how the UK base lending rate remains the highestof the three central bank rates accounts for this paradox.Which bond had the lowest total return? That would be theAmerican 10-year T-note; the low short-term interest rates of

2001-2005 lowered the reinvestment component.This greater currency-adjusted return for the British

bonds has to be some sort of odd revenge of the Law ofUnintended Consequences a law that repeats itselfthroughout market history. We can learn all about humanfoibles from this, but anyone willing to bet an understand-ing of the self-defeating nature of economic policy will causedecision-makers to cease, desist, and abandon their hubris islikely to lose a lot of money in a short period of time.


ADVANCED STRATEGIES continued

The pros make it look hard


Are currency traders making life

unnecessarily difficult for themselves?

Currency trends and volatility

Currency Trader, November 2006.

Interesting insights come from putting currency volatility

under a microscope.

Currencies and conventional U.S. investmentsCurrency Trader, October 2006.

The financial media often reports on moves in the stock and

bond markets vis--vis currency fluctuations, but these rela-

tionships might not be what you expect.

What does the dollar really affect?

Currency Trader, September 2006.

Find out how stocks, gold, and other markets actually respond

to changes in the dollar.

The dollar and its hidden risks

Currency Trader, August 2006.

A look at the dollar in light of its recent performance vs. the

yen and the euro.

Of commodities and currencies

Currency Trader, July 2006.

Analyzing historic market relationships reveals some

interesting facts about movements in many so-called

commodity currencies.

The yen carry trade, currencies, and U.S. bonds

Currency Trader, June 2006.

The latest source of anxiety for bond traders has some surprising

connections to the currency market. Find out the story behind

U.S. Treasuries, the Japanese yen, and the Chinese yuan.

The euro index: The dollar index meets its match

Currency Trader, May 2006.

A look at the development of a viable and tradable euro

index.

The index approach to currency risk management

Currency Trader, April 2006.

Using dollar index futures to hedge non-dollar investments.

The yen stands alone

Currency Trader, March 2006.

The usual rules of the currency world havent necessarily applied

to the Japanese yen. Will that continue to be the case?

Remember the forgotten currency

Currency Trader, February 2006.

Its often labeled a commodity currency, but the Canadian dollar

tends to be ruled by other factors. Heres a look at the factors

impacting Canadian dollar movements.

What drives the dollar index?

Currency Trader, January 2006.

Market watchers often point to deficits and interest-rate

differentials to explain the dollars behavior, but analysis shows

these factors might not be in the drivers seat after all.

Related readingOther Howard Simons articles:

Howard Simons: Advanced Currency Concepts, Vol. 1

A discounted collection that includes many of the articles listed here.

You can purchase and download past articles at www.activetradermag.com/purchase_articles.htm.
http://www.activetradermag.com/purchase_articles.htmhttp://www.activetradermag.com/purchase_articles.htm


35/53



In the latter half of 2006, New

Zealand was the small island

nation with the big currency, asthe kiwi buck gained some 16

percent vs. the U.S. dollar through Dec.

29. In the final 10 trading days of the year

alone, the kiwi gained more than 2 per-

cent against the U.S. dollar a rally that

was bested during this period only by

the New Zealand currencys 3-percent

increase vs. the Japanese yen.

Figure 1 shows the New Zealand dol-

lar/U.S. dollar (NZD/USD) pairs end-

of-year run, which brought the rate to ahigh of 0.7071 on Dec. 29. The move came

on the heels of an October-November

consolidation that was shattered by the

post-Thanksgiving U.S. dollar sell-off

(see Spot check: Dollar breakdown,


A weekly NZD/USD chart (Figure 2)

highlights the pairs meteoric rise off its

June low a move that by last month

was challenging the December 2005 high

of 0.7197 and positioning the currency

SPOT CHECK

New Zealand dollar

The trend has been a friend to

kiwi dollar longs, but all good

things eventually come to an end.

The question is, when?

The statistics send

conflicting messages.

BY CURRE

Currency Trader Magazine 2007.01

Documents

Transcript of Currency Trader Magazine 2007.01