A Forex View From Afar

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Forex Analysis

Price Distribution For The Euro

Written by A Forex View From Afar on Wednesday, December 31, 2008

According to the data compiled from 2006 to the present day, the euro follows a relatively normal distribution. This means, an investor can determine, to some extent, how much the price will move over the following period, in order to gauge risk and determine the possible duration of a trade.

The attached charts show the probability that the close of the next 15 min, 4 hour or daily candle will be bigger than one half of a standard deviation. For example, there is a 70% chance, or one standard deviation that the euro will move ±10 pips over the next 15 min candle.

Knowing this, a trader or a system developer can very easily calculate the exposure to the market, or estimate how long an open order will last. If someone has a 70 pip stop loss, based on the 4 hour chart there is 5% chance, or even smaller, that the market will hit the Stop Loss within the current candle. This is useful when trying to avoid a release, or avoiding a specific time (U.S. open for example)

Euro Price Distribution Forex

The Euro: 10 years and 16 countries

Written by A Forex View From Afar on Tuesday, December 30, 2008

On the 1st of January, the euro will celebrate its first ten years of life, and furthermore, Slovakia will join the Euro-area, meaning the single currency will be used officially in 16 countries.

Initially launched on the first day of 1999 for accounting purposes, the euro was introduced to ease financial transactions, trading and tourism between the initial euro-area block. Back in 1999, the euro was used in 11 countries (Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, Netherlands, Portugal and Spain). Three years later, the euro was introduced in physical form, taking shape in notes and coins. As years went by, four other countries joined the euro-area, Cyprus, Greece, Malta, and Slovenia. The fifth country to join the euro-area, and the 16th in total is Slovakia, scheduled on the 1st of January 2009.

In its history, the euro reached a low of 0.82, in late 2000. Since then, the euro has risen, as the world's leading central banks pledge to increase their euro reserves, thus raising its value. As a consequence, the central bank’s currency reserves held in euros rose from 18.8% in 2000, to 26.5% in 2007, being the second most held reserve currency after the dollar, which as of 2007, represented 63.9% of the total. By mid 2008, the euro reached the 1.60 area, helping the single currency to become the most widespread currency in nominal terms, and also helping the Euro-area almost equal the U.S. GDP.

It also should be noted that both the euro and the Euro-area received a high degree of criticism over its short history. Probably, the height of unfavorable judgment was reached in the summer of 2008, by the time the euro was heading towards the 1.60 area. Some argued that the Euro-area might split, as some countries will enter into a recession (requiring a more adaptive interest rate) while other will try to fight inflation (requiring a more rigorous monetary stance). Despite that these claims have been around since the monetary union first took shape, there has never been official talks (or hints) about such a radical decision.

How much does the S&P have to fall before the Fed contemplates a rate cut

Written by A Forex View From Afar on Sunday, December 21, 2008

When the business cycle changes and heads lower into a trough, usually the equity markets and the Fed Funds start to head lower. The Fed cuts interest rates in order to help the economy, while the equity markets drop as traders’ price in the gloomier earnings perspective.

In the attached chart, we examine the degree the S&P 500 has to fall, in order for the Fed to reduce the targeted Fed Funds rate by 1 basis point. We are going to compare both the S&P downturns in points and percentage, for a better analysis. The S&P crash is not a prerequisite for the Fed to cut, but they usually follow closely.

In the last two decades there have been four notable market downtrends. From each of them, we divided the amount the Fed had cut in basis points to the total points and percentage the S&P lost over the appropriate period.

For example, in the infamous 1987 market crash, the Fed cut 0.40 basis points (0.4%) for every point the S&P lost, while at the same time, the Fed cut 1.42 basis points (1.42%) for every 1% the S&P lost.

It’s interesting to see the similar response the Fed had in the early 90’s, and in current times. In 2001 and 2008, the Fed cut 10 basis points for every 1% the S&P fell. Similarly, the Fed cut roughly 2 basis points for every 1% the S&P lost both in 1987, 1990 and in 1998. Furthermore, it’s amazing to see that almost every crash started in the summer months, except for the Dot-com crash.

However, even back then, in 2001, the S&P was very close in value in the summer months as it was in March, when the high was reached. A short conclusion could be that if something smells funny in the summer months, protect your portfolio with some Calls.

S&P And the Fed

What exactly is the Fed trying to achieve

Written by A Forex View From Afar on Thursday, December 18, 2008

This week, the Fed announced in the FOMC statement that it will maintain expanding its balance sheet, through buying “large quantities of agency debt and mortgage-backed securities” and by open market operations. In the following article we are going to see what, exactly, the Fed is trying to achieve with this.

Having the inflation rate drop like a stone, from 5.6% to the current 1.1% in 5 months, the Fed fears the economy will face a deflationary period. The assets price will decrease, instead of following the normal uptrend, due to the scarcity of natural resources and/or due to the decline in the real value of money (which happens in a normal-working economy).

Generally speaking, deflation comes during recessionary times, although this has not always been the case. In modern times it is, because it shows that the money supply is shrinking due the credit crisis. In other words, despite the Fed’s auction to increase the money supply, the monetary base got thinner and thinner.

Until a few months ago, the Fed influenced the business cycle and the money supply by buying and selling Treasury notes. As we all know, these days, monetary policy has reached its limits, so now the Fed is trying to buy different classes of assets in order to lift their price.

For example, by buying mortgages, as it was said in the statement, the Fed shoots two rabbits with one bullet. It first increases the price for mortgage bills. Due to the reverse relationship between the price and the yield of a bond, yields drop, making mortgages more accessible. Secondly, it will increase the market liquidity, which pretty much dried out during the credit crisis. Thirdly, and more important, it will increase the price for various assets (houses for example) by stimulating demand, raising inflation expectations.

However, theory sometimes has little to do with reality. A similar approach was tried by the Bank of Japan in early 2000, but from my point of view, even now, the Japanese economy has not fully recovered.

Treasuries And Corporate Debt, Two Different Stories

Written by A Forex View From Afar on Tuesday, December 16, 2008

Even though lately, yields on the instruments the U.S. government uses to borrow, treasury notes, have fallen to zero, or close to it, the yields for corporate debt is trading at a record high.

For example, the long term debt paper issued by Verizon, which has an investment grade rating, yields around 9%, while, debt issued by Kodak Eastman yields a whopping 17% for a 5 year maturity period. At the same time, treasuries are trading at records lows and some investors are even accepting negative yields (theoretically the borrower should receive interest from the lender). The equivalent treasury yield for the Verizon loan is around 2.60%, 3 times less, while for Kodak’s debt is 1.50%, 11 times less.

This is pretty much a consequence of a very low liquidity environment and safety flights, not to mention the herd mentality. Investors are selling every possible asset, in order to buy treasury notes, lifting their price. Because of the reverse relationship between the price of a bond and its yield, when investors buy a bond, its yield drops.

Expensive debt means two important things. First, it adds additional expenses since the company would have to pay much more for their debt. Second, it threatens some companies with bankruptcy, because they cannot access liquidity for the daily operations or raise enough cash to water the credit crunch’s consequences.

This is not a healthy environment for business’ to prosper, and it spells trouble ahead. So tomorrow, even thought the Fed had cut 75 basis points, the only real winners are the treasury notes, and not the real economy.

Sentiment Shifting At The ECB

Written by A Forex View From Afar on Sunday, December 14, 2008

The money markets in the Euro-area are currently experiencing a rather unusual event. The EONIA rate or the reference rate in the Euro-area is trading above the ECB’s target of 2.75% for the first time in the last few months.

Furthermore, the EONIA swap contracts, which practically gauge the prime bank’s sentiment over future interest rates, show a humped yield curve, indicating that the market is shifting its view. This comes after the EONIA swap market had a reverse yield curve, which usually indicates that the market expects that the ECB will carry on reducing interest rates.

The most important thing that happens these days in the EONIA swap market is that the spreads between the short-term and the long-term maturity dates are converging, confirming that the market expects the ECB to alter its rate cut cycle. As seen in the attached chart, the spread between the 2 year maturity date and the 1 week has almost approached zero, while it was trading at -0.8 a few weeks ago. The big swing in the European money-markets happened around the same time, subsequent to Mr. Trichet’s speech held one week ago.

ECB interest rate expectations

At the same time, it looks like the currency market has had a similar shift. On the day Mr. Trichet held the usual press conference, the euro managed to find a bottom against the dollar and then gained approximately 600 pips, to reach the highest value for the last two months on Thursday.

The change in sentiment regarding the future ECB interest rate can be a plausible cause for the strong gains the euro posted lately. On Thursday, for example, the euro advanced a strong number of pips, despite U.S. futures running into the red. On negative equity markets, the low yielding currencies, like the dollar and the yen strengthen, however, this was not the case for the dollar. Today, it was the first time in the last few months when the euro advanced on negative U.S. futures. Also, the euro might have been helped by the extremely low yields on the U.S. Treasury notes.

The (un)Usefulness of Fed Funds Futures

Written by A Forex View From Afar on Thursday, December 11, 2008

When someone wants to gauge the market’s sentiment for the Fed Funds rate there are two big choices: take a simple look at the Fed Funds Futures, or extract the probability from the bond market, which is somewhat more complicated because it usually includes a premium.

However, these days, the Fed Funds Futures market is totally hopeless. Why? The answer is simple, but we need to first explain how the Fed works.

The Fed sets its Targeted Rate in the eight FOMC meetings scheduled throughout the year. The Targeted Rate is only a target for the overnight interbanking rate. In normal market conditions, the effective rate, the real banking rate, usually swings in close proximity to the targeted rate. But lately, this has not been the case.

In the last few weeks, the Fed has silently adopted a quantitative easing policy, the effective rate has literally plummeted to zero. For example, in the last two days, the effective rate was set at 0.12%, way under the 1% benchmark.

The Fed Funds Futures market tracks the effective rate, not the Targeted Rate, so, because the Fed lets the effective rate swing wild, the Fed Funds Futures have lost their ability to track the Fed’s next move. This will probably remain as such until the Fed decides to bring back the effective rate near the targeted rate.

A Look Over the New Stimulus Plan

Written by A Forex View From Afar on Tuesday, December 09, 2008

In a televised interview, President-elect Obama announced a new stimulus plan that some believe very likely to help the U.S. economy recover much faster from the credit crunch. Or will it?

Even though the plan was not fully disclosed, the overnight equity markets posted strong rallies. Not fully divulging the coming plan is not something new for U.S. administrations. It all started with Mr. Paulson’s $700 billion fund, of which it is still unclear for what the available funds will be used. The only reference made about the plan was that it will include a public spending program to expand the U.S. infrastructure (e.g. building roads and bridges).

However, from the beginning there have been doubts on how much it will actually help the real economy. The method of “spending the way out of a recession” was first developed in the 1930’s, by Keynes. Back then, most of the economy was based on industry, as extraction of raw materials and their conversion into finished goods. For example, in that period a staggering majority of the Dow Jones index was formed by steel, mining and rail companies.

History shows us that even back then, when the economy was still based on industry, the Keynesian plan did not work properly. First, the U.S. infrastructure is pretty efficient these days, so most investments may not justify their costs. Back then, in the 1930’s, infrastructure was mostly based on bad roads, and mobility was very low. Today, this is not the case. Secondly, if building roads, which eats up a lot of resources, did not help the economy when most of it was still based on industry, how much can it help today, when a huge part of the economy is based on the financial system?

Furthermore, Japan tried to implement an appropriate method to fight deflation in early 2000. Japan faced similar problems as the U.S. economy: credit markets drying up, risk of deflation and zombie banks. Japan invested huge amounts in building roads, highways and bridges, but at the end of the day it still did not help the economy revive in any way. Even today, the Japanese economy is still not working properly. The Japanese bridges and roads built in that period remain known as the “bridges to nowhere”.

In conclusion, there are doubts on how much the plan can actually help the real economy. The market’s answer was pretty strong, but even so, it is hard to see any effects other than widening the Government deficit in the short run. Referring to a longer period of time, the world economy is set to revive by the end of 2009, and from the way construction works, most of these projects will not even start by then

ECB Press Conference Analysis

Written by A Forex View From Afar on Thursday, December 04, 2008

• The Governing Council decided to reduce the key ECB interest rates by a further 75 basis points
• Since September there had been an intensification and broadening of the financial market turmoil
• Tensions have increasingly spilled over from the financial sector to the real economy
• Downside risks to economic activity that were identified previously have materialized
• Global economic weakness and very sluggish domestic demand persisting in the next few quarters
• The economic outlook remains surrounded by an exceptionally high degree of uncertainty
• It is of the utmost importance to maintain discipline and a medium-term perspective in macroeconomic policy-making
• Annual HICP inflation has declined substantially since July
• The significant decline in headline inflation since the summer mainly reflects the considerable easing in global commodity prices over the past few months
• Lower commodity prices and weakening demand lead us [ECB] to conclude that inflationary pressures are diminishing further
• The annual HICP inflation rate is expected to continue to decline in the coming months and to be in line with price stability over the policy-relevant horizon.
• A faster decline in HICP inflation cannot be excluded around the middle of next year, mainly due to base effects. However, also due to base effects, inflation rates could increase again in the second half of the year
• Unexpected further declines in commodity prices could put downward pressure on inflation
• Underlying broad money growth point to a sustained but moderating rate of monetary expansion in the euro area
• The intensification of the financial market turmoil since mid-September marks a potential watershed in the evolution of monetary developments. The most recent money and credit data indicate that this intensification has had a significant impact on the behavior of market participants
• For the euro area as a whole, there were no significant indications of a drying up in the availability of loans
• The underlying pace of monetary expansion has remained strong, bus has continued to decelerate further.
• The level of uncertainty remains exceptionally high
• The Governing Council will continue to keep inflation expectations firmly anchored in line with its medium-term objective
• The Governing Council considers it crucial that discipline and a medium-term perspective are maintained, taking fully into account the consequences of any shorter-term action on fiscal sustainability.

ECB Staff Projections

The ECB Staff Projections had been downgraded significantly from the latest report, published in September. Euro system staff project sees the annual real GDP growth between 0.8% and 1.2% for 2008, between -1.0% and 0.0% for 2009, and between 0.5% and 1.5% for 2010.

The initial GDP projections in September were standing between 1.1% and 1.7% in 2008 and between 0.6% and 1.8% in 2009. Throughout the December projection, the ECB asses the Euro-area will be in a full blown recession in 2009. This is quite a large swing, since earlier this year growth was seen to pick up in 2009.

Referring to inflation, the Euro system staff projections foresee annual HICP inflation of between 3.2% and 3.4% for 2008 and declining to between 1.1% and 1.7% for 2009. For 2010, HICP inflation is projected to lie between 1.5% and 2.1%.

Projections for the CPI read were standing in September between 3.4% and 3.6% in 2008 and between 2.3% and 2.9%. Even thought the initial numbers were rived much lower for 2009, the ECB does not foresee inflation “undershooting” its target, as the BoE does. Furthermore, the large downward inflation revision can also be charge to the strong declines seen in the commodity markets since September, mainly in the crude’s price.


Mr. Trichet put a lot of empathy on the high uncertainty surrounding the financial market and even noticing a change in the market’s behavior. Even though it was not clearly specified which was, Mr. Trichet was probably referring to the market’s risk-aversion.

Overall, the press conference did not bring any surprises, however, Mr. Trichet seemed unwilling to discuss if the Governing Council members had any other alternative than the 75 basis points rate cut. Most likely, opinions diverge during the interest rate meeting, but the Council takes its decisions “unanimously” and “the Council is never pre-committed”. This was the first time when Mr. Trichet refused to talk about the options the central bank had.

Asked if the ECB sees the Euro-area fighting deflation in the coming quarters, Mr. Trichet insisted that the Euro-area is experiencing disinflation (a decrease in the rate of inflation), rather than deflation (negative inflation rate). Also, Mr. Trichet said the ECB is not implementing a quantitative easing policy, but the ECB’s balance sheet had expanded at a strong pace because the bank accepts any bid at a fixed rate. Before the credit crunch, the ECB had auction style open market operations.

Ahead of the ECB

Written by A Forex View From Afar on Wednesday, December 03, 2008

The market awaits the ECB’s interest rate decision tomorrow expecting the bank to cut another 50 basis points, down to 2.75%. The calls for a rate cut have received strong support lately, as the economy is heading towards a full-blown recession and the CPI read is starting to show deflation, rather than any price increase.

Last week, the Euro-area Flash CPI report showed that inflation dropped 1.1% in November to 2.1%, the biggest one month drop on record.
Most analysts say that with this huge drop in the inflation numbers, the ECB has a clear path to ease its monetary policy in the coming meetings. The Euro-area overnight rate, called Eonia, reached 2.91% yesterday, much lower than the ECB’s targeted rate of 3.25%. The difference between the targeted and the overnight rate shows that inter-banking markets now expects at least a 25 basis point rate cut. Some analysts had even increased their forecast for the next meeting held on December 4th, to a 75 basis point rate cut.

However, analyzing the CPI by its components, the biggest increases came from the energy sector. Lately, oil touched a 3-year low, declining close to 60% from the top reached earlier this year. Because of the way the CPI is calculated, rather to absorb over a long term price shocks, the CPI read will continue to decline in the coming months, well under the ECB’s target of 2% over the medium term, giving much more room for the ECB for rate cuts.

The question that comes now is how much exactly has the market “priced in” for any further rate cuts? The euro closed today around the same value it closed on November 6th, after the central bank had slashed the interest rate by 50 basis points. In the last few weeks the euro has managed to find a solid base, but if things do not go as planned tomorrow, we might see a test of recent support areas.

Mr. Trichet’s speech that closely follows the interest rate decision might give some additional clues about the next move the ECB is planning. Until now, the ECB has communicated very clearly with the market, especially when a change in the interest rate direction was prepared. Clear statements are an essential tool for any central bank trying to implement its policy, so a very clear message is expected tomorrow.

Furthermore, traders might find some additional clues about the future interest rate in the ECB’s staff projections, which will be updated tomorrow. The latest projections were released in September, and back then the GDP was set to grow between 1.1% and 1.7% in 2008 and between 0.6% and 1.8% in 2009. It’s very likely these numbers will be downgraded much lower. Also in September, the CPI was projected to grow between 3.4% and 3.6% in 2008 and between 2.3% and 2.9% in 2009. Most say the CPI read will be revised significantly lower.

Looking at Tonight’s BoJ Meeting

Written by A Forex View From Afar on Monday, December 01, 2008

The Bank of Japan has scheduled an emergency meeting for tonight, in response to the strains in the corporate debt market.

This comes, after at the last BoJ meeting, the governing council asked the bank’s members to study the possibility of extending the collateral base to also include corporate debt. The market is expecting this to be one of the main announcements the bank will make.

The decision to include corporate debt will have a positive effect on the Japanese economy. Banks will be able to raise liquidity from the central bank, using corporate loans, which make up a large part of the financial system. As a consequence, the corporate debt market would once again become liquid, making loans less costly for firms.

In the past week, the Governor of the BoJ said, in a number of speeches, that the cost of corporate debt is rising at a very fast pace, not seen since the deflationary period a decade ago. In addition, the Japanese finance minister also announced the economy may experience deflation in the coming years; something that the BoJ has battled since the mid 1990’s but has never really succeeded.

TheLFB Team & The View From Afar Blog

© 2008 A Forex View From a far Trading Blog

Trade Desk View

Fundies and Trading
There is a constant question from some traders as to why anybody would ever need to consider the ‘F’ word when trading. Fundamentals: what is so damaging at looking at both Technical charts and having a Fundamental filter to gauge how many Lots to put on? Why is it that accepting that Technicals give us price points to trade, but Fundamentals determine the direction that we travel is so difficult for some traders to accept? Without a Fundamental Filter very few pure Technical traders would have seen this Dollar move coming today.

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