Currency Trader Magazine 2007.03 by FXCM

VIEWS: 100 PAGES: 53

									                                Strategies, News, and Analysis for FX Traders




 March 2007
Volume 4 No. 3




SECOND-HALF OUTLOOK:       THE POUND IN THE ROUND:
The forex market and       Breaking down
the global economy p. 15   the British currency p. 34
                           DECIPHERING THE MAJOR
RESERVE CURRENCY
                           European cross-rates p. 28
NO MORE?
The dollar at              THE YEN’S SUBTLE SIGNALS p. 22
the crossroads p. 8
    CONTENTS




                                                                Advanced Strategies . . . . . . . . . . . .28
                                                                Comparing the major euro
                                                                cross rates
                                                                Europe’s two major non-euro currencies — the
                                                                British pound and the Swiss franc — reflect the
                                                                growing new currency regime.
                                                                  By Howard L. Simons



                                                                Trading Strategies . . . . . . . . . . . . . .34
     Contributors . . . . . . . . . . . . . . . . . . . . .6
                                                                  Deciphering the British pound
                                                                  The British pound has been a volatile —
                                                                  and mostly bullish — currency in recent
     Global Markets . . . . . . . . . . . . . . . . . . .8        months. Find out how it trades from
       The dollar’s future as a reserve currency                  day to day.
       Dollar doom: Is the world saying goodbye to                By Thom Hartle
       the buck?
       By Currency Trader Staff
                                                                Currency Basics . . . . . . . . . . . . . . . .40
     On the Money                                                The Eurozone
       A rising tide hides the rocks . . . . . .15                A closer look at the Eurozone and why
       A look at the second half of 2007                          countries are — or aren’t — members.
       highlights the prevailing currents
                                                                                                 continued on p. 4
       and riptides in the global forex market.
       By Marc Chandler

       The yen: Canary in
       the currency coal mine           . . . . . . . . . .22
       Keep an eye on capital flows and the yen —
       they could be telling you more about
       the dollar than first meets the eye.
       By Barbara Rockefeller




2                                                                                     March 2007 • CURRENCY TRADER
    CONTENTS




      Industry News
        Japan raises interest rates . . . . . . . .42
        The Bank of Japan raised its benchmark
        interest rate for the second time in less
        than a year.

        More currency ETFs
        hit the market . . . . . . . . . . . . . . . . . . .42
        A pair of exchange-traded funds allows
        traders to profit from the U.S. dollar —                 New Products and Services . . . . . . . . .47
        whether it goes up or down.
                                                                 Global Economic Calendar . . . . . . . . .48
                                                                    Key dates for currency traders.
      Currency Futures . . . . . . . . . . . . . . .43
        Currency fund performance                                Key Concepts . . . . . . . . . . . . . . . . . . . .50
                                                                    References and definitions.

      International Market Summary . .44                         Events . . . . . . . . . . . . . . . . . . . . . . . . . .50
                                                                    Conferences, seminars, and other events.

      Global News Briefs . . . . . . . . . . . . .46             Forex Trade Journal . . . . . . . . . . . .51
                                                                    Going long the euro at short-term resistance.




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4                                                                                        March 2007 • CURRENCY TRADER
                                                                                       CONTRIBUTORS
                                                                                       CONTRIBUTORS



                                                                                                      Thom Hartle (www.thomhartle.com) is
                                                                                                  director of marketing for CQG and a contribut-
                   A publication of Active Trader ®                                               ing editor to Active Trader magazine. In a career
                                                                                                  spanning more than 20 years, Hartle has been a
            For all subscriber services:                                                          commodity account executive for Merrill Lynch,
                  www.currencytradermag.com
                                                                                                  vice president of financial futures for Drexel
                                                                                    Burnham Lambert, trader for the Federal Home Loan Bank of
                                                                                    Seattle, and editor for nine years of Technical Analysis of Stocks
               Editor-in-chief: Mark Etzkorn
              metzkorn@currencytradermag.com                                        & Commodities magazine.

                Managing editor: Molly Flynn
                                                                                                     Marc Chandler (marc@terrak.com) is the
                mflynn@currencytradermag.com
                                                                                                  head of global foreign exchange strategies at
                 Senior editor: Jeff Ponczak                                                      Brown Brothers Harriman and an associate pro-
               jponczak@currencytradermag.com
                                                                                                  fessor at New York University’s School of
                   Contributing writers:                                                          Continuing and Professional Studies. Chandler
              Marc Chandler, Barbara Rockefeller,                                                 has spent more than 20-year analyzing, writing,
                      Howard Simons
                                                                                    and speaking about global capital markets. He has worked for
                  Editorial assistant and                                           a number of consulting firms and banks and did a stint at a
                  Webmaster: Kesha Green                                            hedge fund in the early 90s. Chandler enjoys a high profile in
                kgreen@currencytradermag.com
                                                                                    the business media which often call upon him for insight into
                   Art director: Laura Coyle                                        market developments. He appears regularly on CNBC.
                 lcoyle@currencytradermag.com

                                                                                                      Howard        Simons       is    president   of
                   President: Phil Dorman
               pdorman@currencytradermag.com                                                      Rosewood Trading Inc. and a strategist for
                                                                                                  Bianco Research. He writes and speaks fre-
                     Publisher,
                                                                                                  quently on a wide range of economic and finan-
          Ad sales East Coast and Midwest:
                     Bob Dorman                                                                   cial market issues.
            bdorman@currencytradermag.com

                                                                                       Barbara Rockefeller (www.rts-forex.com) is an inter-
                        Ad sales
           West Coast and Southwest only:                                           national economist with a focus on foreign exchange. She has
                       Allison Ellis                                                worked as a forecaster, trader, and consultant at Citibank and
              aellis@currencytradermag.com
                                                                                    other financial institutions, and currently publishes two daily
             Classified ad sales: Mark Seger                                        reports on foreign exchange. Rockefeller is the author of
              mseger@currencytradermag.com                                          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
Volume 4, Issue 3. Currency Trader is published monthly by TechInfo, Inc.,
150 S. Wacker Drive, Suite 880, Chicago, IL 60606. Copyright © 2007                 Invest Internationally, published in Japan in 1999. A book ten-
TechInfo, Inc. All rights reserved. Information in this publication may not be
stored or reproduced in any form without written permission from the publisher.     tatively titled How to Trade FX is in the works.
The information in Currency Trader magazine is intended for educational pur-
poses only. It is not meant to recommend, promote or in any way imply the
effectiveness of any trading system, strategy or approach. Traders are advised
to 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 not
guarantee future results.




6                                                                                                                   March 2007 • CURRENCY TRADER
               GLOBAL MARKETS




                      The dollar’s future
                      as a reserve currency
       The dollar hasn’t always been the world’s reserve currency, and it might not be in the future.
                             But for now, it’s going to be difficult to knock from its perch.


                                                 BY CURRENCY TRADER STAFF




F           orex players are well aware of the doom-and-
            gloom scenarios that become fashionable from
            time to time regarding the U.S. dollar. Indeed,
            there have been periods in recent history when
concerns about either the huge U.S. twin deficits or the pre-
carious standing of the dollar as the de facto foreign central
bank reserve currency have seized control of the forex mar-
                                                                     the U.S. currency has not collapsed, and for now foreign cen-
                                                                     tral banks (largely Asian) continue to hold trillions of U.S. cur-
                                                                     rency in reserve. In fact, official global central bank reserves
                                                                     are approximately $4.5 trillion as of the first half of 2006 — up
                                                                     from $2.7 trillion in 1999, according to Usha Haley, professor
                                                                     of international business at the University of New Haven.
                                                                     And it is estimated that roughly two-thirds of all global cen-
ket and dominated dollar movement. Examples include the              tral bank holdings in the world are held in U.S. dollars.
late-2004 dollar sell-off and more recently the November                In recent months, however, there has been (prompted by
2006 bearish spiral in the greenback (Figure 1).                     certain central bank announcements) a great deal of market
   However, despite warnings from perennial dollar bears,            chatter about reallocation of reserve assets away from the
                                                                                   U.S. dollar, most notably toward the new kid
                                                                                   on the global currency block — the euro.
    FIGURE 1 — LONG-TERM DOLLAR                                                       “This has been an important issue in global
     The late-2004 and November-2006 dollar downturns were accompanied             markets,” says Michael Woolfolk, senior cur-
     by speculation the dollar was in danger of losing its pre-eminent             rency strategist at the Bank of New York.
     position in the forex world.                                                  “People are concerned about whether the role
                                                                                   of the dollar is under fire.”
                                                                                      Who are the largest holders of U.S. dollar
                                                                                   reserves on the global scene? Are the twin
                                                                                   deficits finally taking a toll on the credibility of
                                                                                   the greenback? Is the U.S. dollar truly losing
                                                                                   some of its allure as a reserve currency? What
                                                                                   other global currencies are credible candidates
                                                                                   for the job? Also, what’s behind the trend in
                                                                                   growing U.S. reserve holdings in recent years?
                                                                                      Given the magnitude of this subject, it is also
                                                                                   worthwhile to examine things from a historical
                                                                                   perspective. When did the U.S. greenback take
                                                                                   on the role of the world’s reserve currency?
                                                                                   What was the evolution of that process and
                                                                                   what lessons from that historical event can
                                                                                   traders apply to their understanding of current
     Source: TradeStation
                                                                                   conditions?



8                                                                                                   March 2007 • CURRENCY TRADER
 FIGURE 2 — WEEKLY PERSPECTIVE

 From the 2002 low to the 2004 peak, the dollar lost around 37 percent vs. the euro.




  Source: TradeStation


What is a reserve currency,                basking in the afterglow of the British
anyway?                                    Empire’s apex in the early part of the
There are many factors that go into        century. The question at hand, of
creating a world reserve currency,         course, is whether that position is
including the non-quantifiable factor      about to be wrested away from the
of trust in the country’s government       dollar in the foreseeable future.
— that is, long-term economic, mili-
tary, and political stability.             U.S. dollar action
   Stability of the currency itself is     After roughly three years of relentless,
another requirement, as are deep and       mostly one-way bearish action in the
liquid capital markets. Another critical   U.S. dollar from the 2002 low in
component is the need for that curren-     euro/dollar (EUR/USD) around 85
cy to be viewed as an international        cents to the 2004 peak around $1.36,
medium of exchange. Also, a world          the bears shaved off around 37 percent
reserve currency can be viewed as a        of the value of the dollar vs. the euro
haven during time of turmoil.              (Figure 2). Since that 2004 peak, a
   “Its value is backed even in times of   large trading range has developed
instability,” says Charmaine Buskas,       between roughly $1.16 and $1.33.
economist at Moody’s Economy.com.             A dollar sell-off in November 2006
“The government guarantees its value       was ostensibly inspired, in part, by
— it’s a risk-free asset.”                 talk of central bank reserve diversifi-
   Although it might seem like the dol-    cation. That month, the euro/dollar
lar has always been the world’s            moved from $1.26 to $1.32 (Figure 3).
reserve currency, that has not been the    Currency watchers say the central
case. Academics generally point to the     bank reserve diversification issue has
end of World War II as the time when       sparked nervousness in the forex
the U.S. dollar took over the role from    arena and is moving markets.
the pound sterling, which was still                                 continued on p. 10


CURRENCY TRADER • March 2007                                                           9
     GLOBAL MARKETS continued



 FIGURE 3 — RECENT ACTION
  In November 2006 the euro/dollar pair moved from $1.26 to $1.32 amid talk of        authorities intervene in the forex mar-
  central bank reserve diversification.                                               kets to the tune of $1 billion every trad-
                                                                                      ing day.
                                                                                         “They are [buying U.S. dollars] and
                                                                                      selling their currency to keep it from
                                                                                      appreciating,”      explains     Michael
                                                                                      Woolfolk, senior currency strategist at
                                                                                      the Bank of New York. “This is the only
                                                                                      way to keep the Chinese currency (the
                                                                                      renminbi, or yuan) from going through
                                                                                      the roof.”
                                                                                         China grabbed headlines in the
                                                                                      financial press in recent months with
                                                                                      news that its reserve assets topped $1
                                                                                      trillion, up roughly $200 billion from
                                                                                      last year. Analyst projections have this
                                                                                      figure growing at about the same pace
                                                                                      in 2007.
                                                                                         China is, simply, the world’s largest
                                                                                      holder of official reserve assets. Bob
  Source: TradeStation                                                                Sinche, head of global currency strate-
                                                                                      gy at Bank of America cites data reveal-
Compounding the issue is the lack of transparency regard-       ing Chinese official reserve assets at $1.06 trillion as of Dec.
ing official reserve holdings and allocation breakdowns;        31. In second place is Japan, at $874.5 billion as of Jan. 31.
central banks don’t necessarily broadcast or even publish       Russia comes in third at $295.6 billion, Taiwan is fourth at
these numbers.                                                  $266 billion (as of Jan. 31), and South Korea is fifth at $240.2
  Market watchers say this factor has already impacted          billion (as of Dec. 31).
U.S. dollar levels.                                                Middle Eastern countries are noticeably absent from the
  “It is one of the main reasons the euro is at $1.31 right     list. Oil-producing nations in the Middle East (as well as
now instead of $1.21,” says Andy Busch, global FX strate-       Russia and some of Latin America) have been beneficiaries
gist at BMO Capital Markets.                                    of the sharp gains in world oil prices in recent years. As
                                                                nearby crude oil futures moved from the $32 per barrel area
Reserve holdings growing                                        in 2004 to the $60-$80 range in 2006, the Middle East saw a
by leaps and bounds                                             windfall of dollar assets (referred to as “petro-dollars”) into
Global foreign reserve assets have been on the rise in recent   their coffers. However, hard numbers from Middle Eastern
years. Data shows Asian central banks and Russian and           central banks are difficult to come by.
Middle Eastern reserve figures growing rapidly in recent           Sinche says Saudi Arabia should be in the top five. One
years.                                                          way the Saudis disguise their true balances is by channeling
   The reasons are quite simple. China and other Asian cen-     funds to the Saudi Arabian Monetary Agency (SAMA).
tral banks have been the beneficiaries of huge export-gener-    Also, Middle Eastern players are known for obscuring the
ated revenues, which come largely in the form of U.S. dol-      amount of their U.S. Treasury purchases by stocking up on
lars.                                                           American fixed-income securities via London investment
   “China is exporting anything and everything to the           houses.
world — that’s what’s causing them to have this influx of
U.S. dollars into their economy,” Buskas says.                  The house of cards theory
   Recent trade figures with China underscore the extreme-      A favored topic of after-hours cocktail conversations among
ly large trade imbalance the U.S. continues to have with that   traders and analysts on the Street is whether the dollar-
country. As of December 2006, the U.S. goods deficit with       doom scenario is just speculation or if the greenback really
China came in at $19 billion, down from a $22.9-billion         is imminently vulnerable.
reading in November 2006.                                          The crux of the issue is the current bear market bias in the
   Other factors driving U.S. dollars into the Chinese econ-    U.S. dollar. And in this regard, huge “structural imbal-
omy include a deluge of direct investments as American          ances” — namely, the record-breaking levels of the current
corporations buy Chinese operations and build manufac-          account deficit — is the story that just won’t go away.
turing and other infrastructure in China. Also, the Chinese        As China’s inflows of U.S. dollars have grown dramati-


10                                                                                            March 2007 • CURRENCY TRADER
cally in recent years, they’ve plowed those proceeds largely        “This scenario has been hanging over the dollar for many
into U.S. Treasury securities. The great fear in some circles    years,” says Bank of America’s Sinche. “Why would they
is the Chinese will abruptly sell their U.S. holdings, spark-    turn around and dump dollars? It would destabilize their
ing a surge in U.S. interest rates and a plunge in the U.S.      exchange rate. It doesn’t make any sense. It doesn’t stand
dollar.                                                          up to the reality of what they are doing and what their
   Talk of Asian central banks pulling the plug on the U.S.-     objectives are. China’s objective is to maintain global stabil-
denominated investments, primarily in the U.S. Treasury          ity. They are trying to develop economically and a big part
market, has sparked shivers in the forex market from time        of that is the export market. They need to have a place to
to time. But most economists will tell you it is simply not in   sell those products.”
the best interests of China to sell U.S. Treasuries in large        However, Sinche offers a scenario in which — at some
numbers.                                                         point in the future — China’s internal domestic demand
   “That’s Y-2K kind of stuff,” Buskas says. “It’s in            market has grown enough that they may no longer be con-
nobody’s interest to shift direction that quickly.”              cerned about external stability.
   Why? First, no matter how much China trims their dollar
exposure, they’ll still have dollar assets and they’d only be    There has been a modest shift
driving the value of their own portfolio lower. Second,          A December 2006 Bank for International Settlements (BIS)
higher U.S. interest rates would negatively impact               quarterly report revealed that there has been a reduction in
American consumer spending and ultimately decrease               dollar holdings by Russia and OPEC.
demand for the billions of dollars of Chinese manufactured         “Both Russia and OPEC have seen a huge influx of for-
products that deluge U.S. shores each month.                                                                  continued on p. 12
     GLOBAL ECONOMY continued




eign exchange from the recent rise in oil prices,” Buskas          Goldstein, economist at the Conference Board in New York.
says. “Among the OPEC nations, dollar holdings were cut            “There is no euro bond or yen bond market that could take
from 67 percent to 65 percent. The two-percent diversifica-        on that role.”
tion went into euro holdings, which rose to 22 percent from           BNP Paribas’ Fabbri, however, calls the euro a “serious
20 percent. OPEC countries reduced their U.S. dollar               alternative,” citing the growth and stability of the euro and
deposits in BIS reporting banks by $5.3 billion. Qatar             euro-denominated instruments.
reduced its U.S. dollar deposits by $2.4 billion.”                    “It is not a rejection of the dollar or our politics, it is a
   Sean Callow, senior currency strategist at Westpac              function of the evolution of the euro and its credibility,” he
Institutional Bank in Singapore, says International                explains.
Monetary Fund (IMF) data shows “global U.S. dollar                    Bob Lynch, head of G-10 strategy at HSBC, agrees.
reserves have fallen from around 72-73 percent in 1999 to 69          “The euro is making inroads,” he says. “It is being used
percent in the third quarter of 2006.”                             as a transaction currency. The liquidity of the euro has
   In other words, diversification out of the dollar has been      steadily increased, which has been an element that has
moderate.                                                          enhanced its appeal as a reserve currency.”
   “Many central banks have said they would look into it,             The British pound was also offered up as a potential alter-
but few have actually done it,” says Brian Fabbri, chief           native reserve currency. Analysts note that Commonwealth
economist at BNP Paribas. “Russia is the only one that is          countries, such as Canada, New Zealand, and Australia,
actually in the process of doing this.”                            likely have a portion of their reserves in the British pound.
   In October 2006, Russian central banks announced inten-            And casting an eye to the world’s emerging economic
tions to diversify into the Japanese yen, which comes on the       powerhouse, Fabbri speculates that in 50 years, perhaps the
wake of a shift down from dollar assets into the euro.             Chinese currency could step into the role.
Russian reserves used to be in the neighborhood of 80 per-
cent dollars, 20 percent euros, but that has changed to            Don’t put all your eggs in one basket
roughly 55 percent dollars, 45 percent euros. Analysts             The question that many currency traders have been won-
would not be surprised if a 50-50 split eventually occurs.         dering about in recent months: Is the desire to reallocate
The move by the Russians, however, is in large part, pat-          central bank reserves a vote of no-confidence in U.S. eco-
terned after their trading activity, which is concentrated in      nomic or political policies — or perhaps just a desire to
Eurozone countries.                                                move away from the bear trend that has dominated the
   South Korea, one of the world’s top-five reserve holders,       greenback since 2002? The answer is perhaps less dramatic.
announced in early February 2007 that it was considering              Global central bank reserve managers ultimately attempt
diversifying part of its growing reserves away from U.S.           to implement the same type of portfolio theory in managing
Treasury securities into overseas blue-chip stocks in an           their country’s reserves as individuals do in saving for
attempt to increase returns.                                       retirement. What’s the common thread? Diversification, of
   The United Arab Emirates, Qatar, and Syria are the other        course.
countries who have announced intentions to diversify away             What is the primary message from global central banks’
from U.S. dollar holdings in recent months.                        intentions to shift away a portion of their assets from dollar
                                                                   reserves?
Other candidates for the job                                          “They are saying that the principle of diversification is
In reality, the pickings are thin for viable contenders to seize   important,” Fabbri says.
the revered global reserve-currency status. Some analysts             “Reallocation toward the euro, pound, and Swiss franc is
suggest the euro has gained some traction in this respect          just good portfolio management,” Buskas says. “Central
since its inception in 1999, but others say it still isn’t up to   bank reserve managers not only manage risk, but seek to
snuff.                                                             deliver a return.”
   “You’re talking about a strategic decision about the way           Central banks have historically invested in low-risk, but
you manage your country’s assets,” notes BMO Capital               also low-yielding assets, such as U.S. Treasury securities.
Markets’ Busch. “The question is: Do you feel comfortable          Deterioration in the U.S. currency, however, can erode
putting your country’s assets into a reserve currency that         income earned from U.S. denominated investments.
has only been around since 1999? That’s why more people               “[However], the dollar is not losing its status as much as
haven’t done it.”                                                  the euro is beginning to establish itself as more of a reserve
   Also, some analysts argue the euro capital markets sim-         currency,” HSBC’s Lynch says. As evidence, he points to a
ply are not deep nor liquid enough to take on this role in the     breakdown of the world’s foreign currency reserves at 65.4
foreseeable future.                                                percent U.S. dollar, 25.4 percent euro, 4.2 percent pound, 3.3
   “There is no alternative to the dollar,” says Ken               percent yen, and 1.5 percent in others.


12                                                                                               March 2007 • CURRENCY TRADER
  “The dollar is still by far the world’s dominant reserve         “All the traditional British clients — Argentina, China,
currency,” Lynch says. “But if global central banks diversi-     and Canada — had to go to New York because the British
fy future incoming reserve flows into other currencies, the      no longer had any more money to lend to the world,” Silber
dollar is the one that ends up losing market share.”             says.
                                                                   Even by 1925, Silber admitted that the U.S. dollar had
The hard numbers                                                 only “come even” with the British pound. Why?
Defying market players who analyze and crunch actual               “It is so hard to overthrow the international medium of
data, central banks are not the most transparent of entities.    exchange,” he says.
   “Regarding data on official holdings of U.S. dollar             Which brings us to the question hanging over today’s
reserves, hard numbers on individual countries’ holdings         marketplace.
by currency are very difficult if not impossible to find,”
Callow says. “Central banks are very sensitive about this.       Is the dollar really in danger?
Imagine if China says it had slashed its U.S. dollar reserves    The resounding answer from academics and global finan-
from, say, 70 percent to 50 percent, the market would imme-      cial markets observers is no. Most strategists expect the
diately reduce the value of its still massive remaining U.S.     greenback to retain this title during their lifetime.
dollar reserves.”                                                   “The traditional safe havens are always going to be the
   Chinese authorities do not issue statements regarding the     same: the dollar, gold, and U.S. Treasuries,” Buskas says.
breakdown of their reserve assets, but market analysts esti-     “In the big picture, the dollar will always remain the
mate that roughly 70 percent of their reserves are held in       world’s reserve currency as long as I’m breathing. The U.S.
U.S. dollar denominated Treasury securities, with 20 per-        has the world’s most deep and liquid capital markets.”
cent invested in the euro and 10 percent in other currencies.                                               continued on p. 14

The historical perspective
For those who managed to stay awake during their high
school history classes, the adage, “The sun never sets on
the British Empire” brings to mind some historical prece-
dence regarding global reserve currencies and how they
can lose that status.
   William Silber, author of the book When Washington Shut
Down Wall Street: The Great Financial Crisis of 1914 and the
Origins of America’s Monetary Supremacy notes that it took
years for the U.S. dollar to topple the British pound as the
world’s reserve currency. From the mid-19th century to the
1914-1925 period, Silber posits that the sterling was clearly
the world’s reserve currency. He points to the outbreak of
WWI in 1914 and the move in which every country but
Britain and the U.S. went off the gold standard as the first
element in that major shift.
    “This put the dollar on the map,” Silber says. “It was an
opportunity for America to behave like a financial super-
power.”
   However, the sterling just didn’t roll over and die.
   “The sterling was the international medium of
exchange,” Silber adds. “It is very difficult to overthrow a
reigning king. There is staying power. Tradition is on its
side. People like to use what they are used to.”
   By the time Britain went off the gold standard in 1919,
because of huge internal inflation problems, America had
continued to make further inroads. Just a few years earlier,
New York had taken over from London as the money-
lender to the world, says Silber. The British, focused on pay-
ing for a war, no longer had capital to lend for internation-
al business projects.


CURRENCY TRADER • March 2007                                                                                               13
     GLOBAL ECONOMY continued




The liquidity issue                                              new reserve funds projected for China on a yearly basis,
Looking at foreign exchange transactions in the internation-     this appears to be a realistic diversification strategy.
al arena, daily turnover in the forex market is estimated at     Nonetheless, even a slowing of the current pace of foreign
$2 trillion.                                                     bank purchases of U.S. Treasury could in and of itself
   “Over 95 percent of all FX transactions involve the U.S.      impact the U.S. interest-rate market and ultimately push
dollar,” notes Bank of New York’s Woolfolk. Even countries       rates higher.
within the NAFTA region need the dollar as an intermedi-            Most analysts believe the Chinese will move cautiously
ary of exchange, he says.                                        in relation to any dollar reserve shifts.
   “If you were to move money from Canada to Mexico, you            “Sure there are concerns,” Fabbri says. “If central banks
would sell Canadian dollars, buy U.S. dollars and buy the        engage in this type of activity it will affect both [U.S.] inter-
Mexican peso because there is no liquid cross between the        est rates and exchange rates.”
Canadian dollar and the Mexican peso,” Woolfolk explains.           HSBC’s Lynch argues it should be a negative factor for
“Also, there is no truly liquid cross between the Canadian       the dollar.
dollar and the pound sterling. There is more liquidity and          “If they slow their purchases, it will create headwinds for
more precise prices in dollar currency exchange rates. As a      the dollar going forward,” he says. Based on this bearish
result, the U.S. dollar has a unique role in the global sys-     factor, he sees potential for euro/dollar to move toward
tem.”                                                            $1.40 by year-end.
                                                                    “It is not as though global central banks are going to
Crude, gold, and other commodities                               begin a mass exodus of the dollar; it will likely be a slow-
Another major factor the U.S. dollar has on its side is that     down of the rate of their dollar purchases,” he says.
the world’s key commodities, such as crude oil and gold,
are priced in U.S. dollars.                                      Looking ahead
   “If South Africa mines gold and wishes to sell it to          One factor, according to some economists, is continued
England, they sell it in U.S. dollars,” says Woolfolk. “If       revaluation of the Chinese currency, which could eventual-
Saudi Arabia sells oil to Japan, the Japanese have to sell yen   ly balance out the current global imbalances situation. With
and buy dollars to pay the Saudis.”                              the American current account deficit around $900 billion on
   Admittedly, there has been talk about the possibility of      an annual basis, a strengthening Chinese currency could
developing a Middle Eastern crude oil futures contract           begin to moderate that gross imbalance.
denominated in euros, and there always remains the possi-           Other economists warn the U.S. economy will eventually
bility that someday OPEC will sell its prized oil reserves       have to pay the piper.
priced in euros instead of dollars.                                 “You have to wonder exactly how the U.S. is going to
   “[This scenario] may not be independent of political          keep current on its interest and dividend payments to the
problems that the Middle East has with the U.S.,” Woolfolk       rest of the world,” says Paul Kasriel, director of economic
says.                                                            research at Northern Trust Co. in Chicago. He believes the
   But Woolfolk doesn’t expect that scenario to play out         rising levels of government and household debts are worri-
anytime soon because of the unique role the U.S. dollar has      some.
within the global foreign-exchange transaction system.              “What are we doing with all this capital?” he asks. “Are
                                                                 we pouring it into productive investments that will enable
A bearish market factor                                          us to grow faster in the future?”
Buskas says reserve diversification is an important driver          Kasriel concludes Americans are, indirectly, channeling
for the U.S. dollar. She suggests it will be one of the top      the incoming asset flows from foreign central bank pur-
three factors impacting currency movement in 2007.               chases of U.S. denominated securities into “the construction
   “The big elephant in the room is China,” says BMO             of McMansions and purchasing big screen TVs and SUVs.”
Capital Market’s Busch. “What are they going to do with
their dollar reserves? It is one of the biggest unknowns out     Print our way out of the mess?
there in the capital markets.”                                   The bottom line is the U.S. is running a highly leveraged
   However, Busch notes that the U.S. Treasury department        economy, and things could get ugly for American con-
is actually working with China on how to proceed.                sumers if slowing foreign central bank purchases triggered
   “The last thing the Chinese want to do is spark a dramat-     higher interest rates.
ic dollar sell-off,” he says.                                      “Higher interest rates are the enemy of leverage,”Kasriel
   Some market watchers have suggested China and other           says. “[They could ultimately make it] difficult for the U.S.
global central banks will implement diversification tactics      to service our debt and enjoy a rising standard of living.
via incoming flows of funds, as opposed to outright selling      That is where printing money could become a political
of current holdings. And, given the roughly $200 billion         viable alternative.”


14                                                                                             March 2007 • CURRENCY TRADER
           ON THE MONEY




                                  A rising tide
                                  hides the rocks
          The global economic seas are smooth for the time being, but traders should be aware
                                of the very real risks lurking just below the surface.

                                                   BY MARC CHANDLER




T
eral months.
             he investment climate continues to be charac-
             terized by high liquidity and low volatility,
             and there is little reason to expect a significant
             change in those conditions over the next sev-

   That means current investment strategies — which favor
                                                                  faster than nominal GDP. Chinese and Indian money sup-
                                                                  ply is also expanding rapidly.
                                                                     Japan is the chief exception, but it is noteworthy that
                                                                  despite the sluggish growth in the country’s monetary base
                                                                  since its current account balances were normalized last
                                                                  year, bank lending remains positive.
pursuing returns over safety — are likely to persist, even           Critics of this liquidity explanation point to the circular
after the late-February lurch in equity markets. The pendu-       reasoning often surrounding it, or its elusive definition.
lum that swings between fear and greed should remain              Yet, the power of the thesis lies in its broad explanatory
closer to the latter.                                             ability. It explains both the persistent yen weakness and the
   Many central banks have raised interest rates over the         Swiss franc’s underperformance, and it also helps explain
past nine months. Several key central banks, including the        the persistent strength of high-yielding currencies, such as
European Central Bank (ECB), the Bank of Japan (BOJ), the         the New Zealand dollar (NZD), despite its large current
Bank of England (BOE), the Swiss National Bank (SNB), the         account deficit, and the Brazilian real (BRL), despite daily
Reserve Bank of New Zealand (RBNZ), and Norway’s cen-             intervention by the Brazilian central bank.
                                                                     The liquidity hypothesis helps explain numerous other
                                                                  market developments outside the forex arena:
If the economy resumes an upward
                                                                    • A long and sustained bull market in global equities.
trend, as the Federal Reserve                                       • Relatively low yields despite mature business cycles.
                                                                    • Tight credit-quality spreads, including corporate
forecasts, the interest-rate tightening                               and high-yield bonds over Treasuries.
                                                                    • The ongoing appeal of emerging-market assets.
cycle might resume in late Q3                                       • Sustained low volatility across asset classes.
                                                                    • A continued boom in mergers and acquisitions
or early Q4.                                                         (M&A).

                                                                     This conceptualization of liquidity also includes financial
tral bank (Norgesbank) are all expected to raise rates again      engineering. Various instruments, such as asset-backed
in the coming months. The central banks of Brazil and             securities, allow companies to extend the credit cycle inde-
Indonesia stand out as notable exceptions.                        pendent from the central bank. Similarly, and especially in
   However, the price of money is only one dimension of           the U.S., the development of new mortgage products, such
monetary policy; the other is quantity. And there are few         as those that allow buyers to pay interest on no principal, or
signs that liquidity has been dampened. Money supply, as          the popularity of adjustable-rate mortgages, effectively
measured by M3, for example, is expanding significantly           extends the credit cycle for many households.
faster in the Eurozone now than it was when the ECB first             The high liquidity also sheds light on why prevailing
began raising interest rates in December 2005. Broad money        prices do not seem to be accounting for risk properly
supply in the UK and the U.S. appear to be expanding                                                           continued on p. 16


CURRENCY TRADER • March 2007                                                                                                  15
     ON THE MONEY continued

 FIGURE 1 — EURO/U.S. DOLLAR
  The easing of short-term U.S. rates and the narrowing rate differential
  with the Eurozone was accompanied by a down move in the dollar in             the Eurozone, where growth appeared more
  Q4 2006 (shown here by the up move in the euro/dollar pair).                  solid in Q4, was accompanied by a down move
                                                                                in the dollar (Figure 1).
                                                                                   In his semiannual testimony before
                                                                                Congress, Federal Reserve Chairman Ben
                                                                                Bernanke appeared more confident current
                                                                                policies would foster sustainable growth and
                                                                                the gradual ebbing of core inflation — the pic-
                                                                                ture-book definition of an economic “soft-land-
                                                                                ing.” While housing still posed a risk to
                                                                                growth, the greater risk remained that core
                                                                                prices would prove sticky.
                                                                                   Bernanke, who has eschewed the strategic
                                                                                ambiguity of his predecessor, Alan Greenspan,
                                                                                was clear: While there were some indications
                                                                                inflation pressures were beginning to moder-
                                                                                ate, the data was noisy and “it would be some
                                                                                time before we can be confident that underly-
                                                                                ing inflation is moderating as anticipated.” The
                                                                                unequivocal message from the Federal Reserve
  Source: TradeStation                                                          is that inflation is decidedly on hold.
                                                                                   Although not without critics, Bernanke’s
according to the models of economists and policymakers.           first year at the Fed’s helm compares quite favorably with
As whitewater rafters know, ample water hides the rocks           his two immediate predecessors. And even with one of the
and makes a calmer surface. So too, is the case with liquid-      most inexperienced Federal Reserve Boards in history, its
ity in the capital markets.                                       economic forecasts have been uncannily accurate.
   While the improvement of macroeconomic fundamentals               The most significant exception was the continued strong
in numerous emerging markets is undeniable, it is likely          performance of the U.S. labor market. The jobs data has
this improvement might account for a little more than half        been subject to substantial revisions that often make the ini-
of the convergence in interest rates and a smaller portion of
the increased correlation between emerging market indices,
such as Brazil’s Bovespa and the U.S. S&P 500.
                                                                   The ECB is likely to raise interest
Interest rates: A patient Fed                                      rates not only in March, but also
Short-term interest-rate differentials can explain the dollar’s
movement — especially for the critical euro-dollar relation-       in Q2 2007.
ship (see “The dollar super-cycle,” Currency Trader, March
2006).                                                            tial reports quite unreliable. The government initially esti-
   Between early December 2006 and late January 2007, the         mated that 3.3 million jobs were created between March
market took back the nearly 50 basis points (bps) in Federal      2005 and December 2006 but, upon review, the government
Reserve rate cuts it had priced in to the term structure, even    found another million jobs. The strength of the labor market
though the Fed on numerous occasions indicated that, from         is the key to consumer spending, which accounts for nearly
its perspective, the upside risk of inflation was greater than    70 percent of the economy. Despite weakness in home prices
the downside risks to growth. The euro pulled back nearly         and a startling 19.2-percent collapse in residential construc-
a nickel as the interest-rate expectations were adjusted (see     tion, real consumer spending in Q4 grew at a 4.4-percent
Figure 1).                                                        annual rate, the second-strongest quarterly performance in
    The pendulum of market expectations swung as far as           three years.
macroeconomic performance would allow. By the middle of              Moreover, in the recent past, the real fed funds rate (cur-
February it became clear the preliminary estimate of U.S. Q4      rently around 3 percent) has needed to be higher than pre-
GDP of 3.5 percent would be subject to a substantial down-        vailing levels to sustain non-inflationary growth. In 1994-
ward revision to reflect new trade, inventory, and construc-      1995, the real rate was closer to 4 percent, and in the 1999-
tion data. Moreover, on balance, indications point to growth      2000 period, it reached 5 percent. If monetary policy acts
in the 2.0- to 2.5-percent range for Q1 2007. The easing of       with a six- to nine-month lag, the effect of the Fed’s tighten-
short-term U.S. rates and the narrowing differential with         ing through mid-2006 should be diminishing just as the


16                                                                                             March 2007 • CURRENCY TRADER
                                                    FIGURE 2 — BRITISH POUND/U.S. DOLLAR
                                                    The British pound has traded above $1.90 a handful of times in recent
                                                    history, but it has not sustained these moves..
drag from the housing market, autos, and inven-
tory adjustments are starting to decline.
   Assuming the economy returns to the path of
trend growth as the Federal Reserve forecasts,
the tightening cycle might resume in late Q3 or
early Q4.

The European Central Bank:
More hikes before pause
Although this Fed interpretation view may dis-
courage being too bearish the U.S. dollar over the
medium term, the next few months is a different
story. The ECB is likely to raise interest rates in
both March and the second quarter, which will
likely continue to support the euro even though
these hikes have largely been discounted.
   With the region’s price pressures moderating
because of declining energy prices, the ECB may
be content that, with its refinance rate near 4 per-
cent by mid-year, it has normalized monetary          Source: TradeStation
conditions. The euro may be especially sensitive
to how the ECB signals its intention to pause. The Federal tiveness on the periphery of the Eurozone, something that
Reserve arguably has encountered some challenges in con- can be overlooked when looking at aggregate figures.
vincing the market that a pause, even if protracted, is not                                          continued on p. 18
the same thing as the end of the cycle.
The transparency and predictability the
market has come to expect from the ECB
may be more difficult to sustain as poli-
cy reaches neutrality.
   Outside of Germany there has been a
lack of significant structural reforms in
the Eurozone. Particularly, low produc-
tivity — despite a cyclical upturn —
undermines longer-term confidence. It is
difficult to envision the Eurozone’s econ-
omy sustaining growth much above 2
percent.
   Workers in Germany’s engineering
and chemical sectors may get wage hikes
in excess of 3 percent, with labor action a
distinct possibility in the former area.
However, other parts of the economy,
including the public sector, retail, and
construction will be hard pressed to
strike the same kind of deals.
   In other parts of the Eurozone, such as
Spain, Portugal, and Italy, wage agree-
ments are likely to be in excess of pro-
ductivity gains. After all, Spain and
Portugal experienced an outright decline
in productivity growth in 2006 (-0.5 per-
cent and -0.3 percent, respectively), and
Italian productivity rose a negligible 0.1
percent. This hints at a loss of competi-


CURRENCY TRADER • March 2007         17
     ON THE MONEY continued




   European growth remains export-driven, and this “bor-           ment. In the U.S., there is a divided government for the first
rowing” from the world’s growth has been a critical part of        time in seven years. President Bush’s public approval rating
the region’s economic recovery. Consider that in 2000,             is low and posturing for the 2008 presidential race has
German exports were 33 percent of GDP and by last year             already begun. France goes to the polls this spring and there
had increased to more than 40 percent. Austria, Belgium,           is much speculation of President Jacques Chirac’s legal
the Netherlands, and Ireland exported more than 50 percent         problems as soon as he loses the immunity of his office.
of their GDP.                                                      Italy’s center-left coalition was strained over the budget
   Another year of strong world growth bodes well for the          vote at the end of 2006 only to collapse in February over a
region and the ECB is more likely to lift rates above 4 per-       minor foreign policy decision. Germany has a grand coali-
cent rather than peak below.                                       tion government of the two main parties, the CDU/CSU
                                                                   and SPD.
The surprising Bank of England                                        The weak leadership does not appear to be much of a
If the UK’s monetary policy is not as dull as he thinks it         market consideration at the present. However, should cir-
should be, BOE governor Mervyn King has to look no fur-            cumstances arise that demand bold leadership, the markets
ther than his own office to find the culprit.                      will exact a price for its absence.
   Bernanke is committed to making Fed decision making                The pound (GBP) has traded above $1.90 a handful of
more transparent and has created a committee to find ways          times over the past quarter of a century (Figure 2).
to improve its communication. At the ECB, President Jean-          Although it might spend a few months above this level, it
Claude Trichet has developed a stable of word clues (e.g.,         has not sustained these moves. By some measures of pur-
“strongly vigilant”) to signal its policy intentions. But the      chasing power parity, sterling is one of the most over-val-
BOE almost seems to glory in surprising the market, which          ued of the major currencies — which is not to say sterling is
it has done not once but twice in the past several months.         about to collapse or that it cannot make another push
   In fairness, the timing surprised the market more than          through $2.00.
                                                                      However, the overvalued pound is likely to influence
                                                                   investors in a couple of channels. We would expect
Although yields are lower in Asia,                                 investors to respond by taking advantage of upward spikes
                                                                   to layer in hedges, especially on fixed-income exposures
the prospect for currency appreciation                             and after the BOE tightening cycle appears to have peaked.
                                                                   Also British corporations may increasingly become acquir-
is greater than in Latin America.                                  ers in the global M&A boom to take advantage of the strong
                                                                   sterling.
                                                                      Investors who have not been dissuaded by the high price
the direction of rates. King clearly indicated the BOE’s eco-      of the pound from purchasing a real UK asset may prefer to
nomic forecast assumes another hike in rates to 5.50 per-          borrow the currency rather than buy it. Offsetting a pound
cent, taking the British rate above the U.S. fed funds rate for    asset with a pound liability neutralizes the currency expo-
the first time in a couple of years.                               sure.
   The market expects the hike to be delivered in the second
quarter. It may be difficult to surprise the market a third        The Bank of Japan:
time, but it is possible. The market does not like surprises       Limited impact from hikes
and requires compensation for the risk. An increase in risk        The most compelling explanation of the persistent Japanese
premium around BOE meetings is the likely price for the            yen (JPY) weakness that has so flummoxed European
BOE’s tactics.                                                     finance ministers and U.S. auto producers in January and
   It seems almost inevitable that the UK’s Chancellor of the      February are the low Japanese interest rates and the steep-
Exchequer, Gordon Brown, will become the next Prime                ness of the curve, which offers attractive financing and
Minister when Tony Blair steps down later this year. At this       hedging opportunities. But the BOJ’s rate hike in February
juncture, it is not clear that Brown will be able to seek a pub-   may prove insufficient to put a solid floor under the yen.
lic mandate by calling for elections. Just as the British elec-       The UK, Sweden, and Norway have already hiked rates
torate grew weary of the Tories under the long reign of            this year. The Eurozone, Switzerland, and New Zealand are
Margaret Thatcher and John Major, it now seems fatigued            not far behind. The BOJ rate hike merely stabilizes the short-
with the Labour party. Remember this is an electorate that         term interest-rate differentials where they were at the end of
loved Winston Churchill but turned him out of office, too.         2006. Indeed, given those prospective rate hikes, the risk is
   In another way, though, Brown’s vexing situation is             that interest-rate differentials may not have peaked yet.
symptomatic of a larger challenge within the other G7 coun-           That said, in the second half of the first quarter and into
tries — weak governments. Canada has a minority govern-            early Q2, there are a few factors that may stymie the yen


18                                                                                              March 2007 • CURRENCY TRADER
                                                 FIGURE 3 — U.S. DOLLAR/JAPANESE YEN
bears. First, after the milquetoast G7            Using the recent past as a rough guide, the U.S. dollar could fall five
statement, net speculative short yen              to six yen from its peak above 122.00.
positions at the IMM set new record lev-
els. The yen may strengthen when these
positions are adjusted.
   But speculators might not be the only
source of demand. Ahead of the fiscal
year-end at the end of March, Japanese
institutional investors typically repatri-
ate funds back home largely for win-
dow-dressing purposes. Weekly data
from the Ministry of Finance suggests
this has already begun. At the same
time, foreign appetite for Japanese
stocks remains robust.
    Policy makers, investors, and jour-
nalists have expressed concern about
the impact of the unwinding of yen
carry trades. Much of the angst appears
exaggerated and a function of empha-
sizing the role of speculators too much.
Between late October and early                     Source: TradeStation
December, the net short yen futures (JY)
speculative positions at the Chicago          predicated on the private sector recy-
Mercantile Exchange were dramatically         cling the current account surplus.
cut — by more than 80 percent — from             In turn, the private sector’s appetite
137,300 contracts (each worth JPY12.5         for foreign investment is a function of
million) to 23,500. Markets remained          the low returns available at home. The
orderly. In fact, during this unwinding       low returns are not just limited to inter-
of short yen positions, the Euro, sterling,   est rates, but also extend to the return on
Australian dollar, and many other cur-        equity. MSCI calculations estimate the
rencies continued to appreciate against       average return on equity of Japanese
the Japanese currency. The dollar itself      companies is 8 to 9 percent, compared
though fell four to five yen.                 with the mid-teens for European com-
   One of the reasons for this counterin-     panies and high teens for U.S. compa-
tuitive development is that the yen carry     nies.
trade appears to be in more stable               It appears the opportunity to normal-
hands. Japanese investors themselves          ize Japan’s monetary policy in this cycle
have been significant sellers of yen and      has already passed. Although the
buyers of higher-yielding securities. In      Japanese economy is enjoying its
the current fiscal year that began in         longest expansion in modern times,
April 2006 through the end of the year,       price pressures remain practically non-
for which monthly data is available,          existent. The GDP deflator is still nega-
Japanese investors bought more than           tive (-0.5 percent in Q4 2006). With the
$75 billion of foreign assets.                fall in energy prices, producer prices
   These purchases of foreign assets by       likely have peaked. The BOJ forecasts
Japanese investors are a salutary devel-      less of a rise in 2007 than in 2006.
opment. It means the private sector is        Consumer prices also appear to be peak-
recycling the country’s current account       ing just above zero.
surplus, which in turn means the gov-            Fiscal policy has not been normalized,
ernment does not have to. Indeed, the         either. Despite the sustained economic
BOJ has not intervened in the foreign         upswing, the budget deficit is still in
exchange market in three years and its        excess of 4 percent of GDP. The decline
ability to remain on the sidelines is                                     continued on p. 20


CURRENCY TRADER • March 2007                                                             19
      ON THE MONEY continued


FIGURE 4 — U.S. DOLLAR/MEXICAN PESO
                                                                                     Some emerging-market
The Mexican peso/dollar rate has been fluctuating in a broad trading range for       implications
several months.
                                                                                      On a net basis, futures speculators have
                                                                                      not been long yen (or Swiss francs, for
                                                                                      that matter) since last June. This may
                                                                                      also be a helpful guide of the so-called
                                                                                      “hot-money’s” appetite for the carry
                                                                                      trade and may increase pressure not only
                                                                                      on the Australian and New Zealand dol-
                                                                                      lars (beneficiaries of the carry trade), but
                                                                                      emerging markets in general.
                                                                                         The ample global liquidity conditions
                                                                                      and favorable world growth dynamics
                                                                                      may continue to underpin emerging
                                                                                      markets in general over the next several
                                                                                      months. Given the record low EMBI+
                                                                                      spread over Treasuries (around 165 bp),
                                                                                      it is difficult to envision strong out-per-
                                                                                      formance going forward. This appears to
                                                                                      have encouraged interest in taking on
Source: advfn.com                                                                     local currency risk, especially in Latin
                                                                                      America.
                                                                                         Although yields are lower in Asia, the
in Prime Minister Shinzo Abe’s support rating and his lack       prospect for currency appreciation is greater than in Latin
of a popular mandate in the first place may have deterred        America. Brazil’s central bank, which has been intervening
much of a discussion of fiscal policy. However, the focus is     daily for more than six months, has stepped up its opera-
likely to shift from monetary policy to tax hikes to close the   tions. The Mexican peso/dollar rate (MXN/USD) appears
budget gap.                                                      comfortable in its broad trading range between 10.85-11.10
   It is also not clear that consumption, which accounts for     (Figure 4).
55 percent of Japan’s GDP, will offer much support for the          There are two sources of broad upward pressure on
economy. The strong showing in Q4 2006 (1.2 percent)             Asian currencies. The first is coming from foreign inflows
needs to be partly understood as payback for the 0.4 per-        into the equity market. Foreign inflows into the Philippines,
cent decline in the previous quarter. Since 2000, consump-       have been particularly strong at the start of the year, but the
tion has risen by a quarterly average of 0.33 percent. The       decline in the pace of flows into Taiwan’s shares should not
quarterly average for the past two years is nearly twice as      obscure the fact that in the first six weeks of the year, for-
high, but still remains paltry at 0.62 percent.                  eign demand for Taiwanese equities ($1.4 billion) was equal
   Wages rose 0.2 percent last year after falling 10 percent     to the combined inflows into South Korea, the Philippines
between 1997 and 2005. To the extent that the weak wage          and Indonesia. Add India and Thailand, and you can
gains limit potential consumption, investors are advised to      account for more than $3.3 billion of foreign demand. The
pay attention to monthly compensation figures the govern-        average of a little more than $500 million a week is off last
ment publishes with the monthly labor market report.             year’s record pace to be sure, and although the data is hard-
However, while stronger wage increases are necessary, it         ly comprehensive, it still suggests a source of upward pres-
might not boost consumption. In recent years, household          sure on local currencies and speaks to the total return of
savings have been drawn down, partly to sustain con-             either fixed income or equity investments in the region.
sumption levels.                                                    The second force that may also encourage regional cur-
   These considerations suggest the yen’s recovery in the        rency appreciation is China. Although still too slow for its
second half of Q1 is unlikely to be sustained. Using the         critics, the pace of yuan appreciation has accelerated.
recent past as a rough guide, the U.S. dollar could fall five
to six yen from its peak above JPY 122.00 (Figure 3). Such a        U.S. dollar movement           Length of time
pullback would bring the 200-day moving average, now                CNY8.10-CNY8.00                10 months
near 117.00, into play. A band of technical support extends         CNY8.00-CNY7.90                4 months
toward 115.00. In terms of time and levels, this may corre-         CNY7.90-CNY7.80                3 months
spond to the deployment of Japanese investment capital
overseas early in the new fiscal year.                              This suggests about a five-percent annualized apprecia-
                                                                 tion of the yuan against the dollar in 2007. This is a little less


 20                                                                                             March 2007 • CURRENCY TRADER
                                                                  Related reading
                                                                  “Marc Chandler collection”
                                                                  In this discounted compilation of past Currency Trader
than currently discounted by the non-deliverable forward          and Active Trader articles, Marc Chandler addresses a
market, which makes sense insofar as Chinese officials are        wide range of macroeconomic, market, and currency
loath for speculators to profit from the adjustment process.      issues and strategies.
There are several regional currencies that have a good prob-
ability of out-performing the yuan in the coming months.          You can purchase and download past articles at
These include the Thai baht, Philippines peso, Malaysian          www.activetradermag.com/purchase_articles.htm.
ringgit, and Singapore dollar.
   While the favorable investment climate and weak U.S.
dollar undercurrent may lend support to east and central            Rise of protectionism. Rising protectionist sentiment has
European currencies, the medium term view is not as con-         been kept in check, but weakened governments may have
structive. Macro-economic variables are out of balance and,      to accommodate that sentiment. Ironically, the rise of pro-
without the discipline imposed by the drive to join EU or of     tectionism is occurring as the global economy moves into
trying to enter the eurozone as early as previously antici-      better balance: U.S. budget and trade deficits have been
pated; the sense of urgency for reforms has slackened. Rate      reduced, Europe and Asia are experiencing strong growth,
convergence has already largely taken place, and a number        and Asian currencies have appreciated and become some-
of fund managers have added the Czech koruna to the bas-         what more flexible.
ket of financing currencies.                                        Renewed appreciation of commodities. This may call into
                                                                 question — or even reverse — the easing of price pressures,
The pace of Chinese yuan                                         fueling tighter monetary policy than discounted. The impli-
                                                                 cations on the terms of trade for some countries, such as
appreciation has accelerated —                                   Australia, Canada, South Africa, Chile, and Brazil, for
                                                                 example, may be beneficial.
                                                                    Capital controls. Thailand clumsily introduced capital
about five-percent vs. the dollar                                controls in late 2006, only to incrementally introduce excep-
                                                                 tions, and by early Q1 the strength of the baht had returned
in 2007.                                                         and the central bank was thought to be intervening again to
                                                                 slow the currency’s rise.
Stay on top of the risks                                            Other countries being deluged by foreign investors have
Market conditions never remain static, and because of the        few positive lessons to take from Thailand’s experience.
inherent uncertainties of macro forecasts such as this, there    Countries such as South Korea and China are liberalizing
are several risk factors traders should monitor.                 outgoing foreign-investment restrictions. Nevertheless the
   Hard-landing of the U.S. Economy. There are still a num-      success of Malaysia’s experience from 1997 to 2005 with cap-
ber of seasoned observers who argue the Fed is, in effect,       ital controls may encourage other countries to, when faced
asleep at the switch. The argument is that a sharp fall-off in   with such challenges, see the cost of capital controls as cheap-
economic activity ostensibly triggered by a bursting of the      er than the politically and economically viable alternatives.
housing market bubble will lead to dramatic cut in U.S.             Many consider Vietnam, whose stock market is up near-
interest rates.                                                  ly 45 percent in the first half of Q1 alone (and more than 230
   A softish 2.0 to 2.5 percent Q1 2007 GDP seems largely        percent over the past 52 weeks through mid-February), as a
baked into the cake. But if the slowdown appears to extend       likely candidate for capital controls.
into Q2, the dollar could be weaker than anticipated here.
   Enlargement or intensification of turmoil in Iraq. In dis-    For information on the author see p. 6.
cussions with clients, the
expansion of the war in Iraq
into a larger regional conflict
that would include Iran has
been a repeated theme. Such
a development could be a
potential shock for the global
economy. Although most of
U.S. oil and gas imports
come from Canada, Mexico,
and Venezuela, the potential
disruption would likely
increase the dollar’s down-
side risks.


CURRENCY TRADER • March 2007                                                                                                   21
            ON THE MONEY




                                               The yen:
         Canary in the currency coal mine
           The Japanese yen may play a pivotal role in warning of a potential dollar disruption.


                                                BY BARBARA ROCKEFELLER




Y               ear after year, professional analysts at banks
                and brokers forecast the dollar will fall against
                the Euro because of the disastrous twin cur-
                rent account and budget deficits. Ho hum.
  Year after year, the dollar may fall on a net year-over-year
basis, but not (so far) by disastrous amounts. In 2006, the
dollar fell 11 percent vs. the euro, but this is not panic sell-
                                                                    exchange rate, which is a function of the leverage being
                                                                    used and the net differential being earned, and nobody
                                                                    knows the collective breakeven exchange rate.
                                                                       Lets say that the early-bird carry traders started at the
                                                                    beginning of the yen down move in January 2005 when the
                                                                    dollar/yen (USD/JPY) was at 103.00, used leverage of two
                                                                    times, and got a net differential of 5 percent. Excluding rein-
ing. In fact, the dollar has been a net gainer against the other    vested gains, the yen can rise 10 percent from the starting
major currency, the Japanese yen (only 1.5 percent but a            point to 92.70 before that carry-trader needs to exit.
gain is not a loss).                                                   That’s the extreme best-case scenario; in practice, many
  The reason for the dollar’s firmness against the yen is the       carry traders probably got in at the median price of 117.00.
much-referenced carry trade. Hedge funds and others bor-            So, with the same assumption of a 10-percent breakeven,
row yen at 0.50 percent and invest it in other currencies at        they need to start worrying when the yen gets around
rates ranging from 3.5 percent to 7.5 percent and keep the          105.00. That’s a long way away — the yen is currently
difference. A net differential of 3 percent to 7 percent            above 120.00 — and you’d have to be comatose not to notice
sounds like a small amount, but double or triple that               a 15-yen move. Naturally, no investor would wait until the
because of the effect of leverage, and suddenly you’re look-        last minute. Carry traders believe in trends as much as the


               The yen could be the canary in the coal mine that warns us
                    the long-forecast dollar debacle is finally upon us.
ing at some interesting amounts of money.                           rest of us, so any hard evidence of a yen uptrend would
   Meanwhile, Japanese investors are also placing their             trigger exits well ahead of the true breakeven levels, fueling
funds abroad. Even ordinary citizens can place funds in for-        any movement and turning it into a true trend.
eign-currency denominated accounts offered by banks and
brokers, many of them with built-in exchange rate hedges.           Possible scenarios
Because Japan is just coming out of a near-decade of defla-         What event or shock would trigger a yen up move? It’s a
tion — and will probably dip back into deflation this year          critical question because the dollar is strong only against
— nobody expects the country to have competitive interest           the yen. Remove that leg of support, and perhaps it’s the
rates any time soon. Therefore, the carry-trade gravy train         occasion of the much-vaunted dollar collapse. While it’s
could go on indefinitely and other countries with higher            true that exchange rates tend to be highly correlated with
interest rates (including the U.S.) can count on capital            growth, and Japan has high growth right now (4.8 percent
inflows indefinitely, too.                                          year over year in Q4 2006), the correlation is usually due to
   What upsets this apple cart, of course, is a rise in the yen     high-growth situations being accompanied by rising infla-
that would make those yen loans overly expensive to pay             tion. In the Japanese economy, where domestic consump-
back. Every carry trader knows his own breakeven                    tion is relatively lower than in the U.S. and Europe, this


22                                                                                               March 2007 • CURRENCY TRADER
connection is weak. It is different for Japan, because Japan      sidered “reserves,” although there is no rationale for nam-
can have high growth without getting inflation.                   ing domestic Chinese investment “reserves” — it’s simply
   Or maybe the dollar collapses and that causes the yen to       plain, old-fashioned government spending. All the same,
rise along with all other currencies. As we have seen, talk of    the impetus for diversifying reserves is to get a more varied
a dollar collapse is mostly based on exaggerated claims of        portfolio and a higher return than in U.S. paper, even at
the importance of the current account deficit. Even a mas-        higher risk.
sive devaluation of the dollar will not improve trade by             The second chink is the December capital inflow of a
much because the playing field is so uneven. The U.S. today       measly $15.6 billion after $84.9 billion in November, revised
imports much of what it used to make, from wooden                 up from $68.4 billion. This is less than 20 percent of the
matches to socks to electronics. And there is a limit to how      month before, and only 25 percent of the December trade
many Boeing airplanes, Caterpillar tractors, and tons of          deficit of $61.2 billion.
grain that foreigners can afford to buy from the U.S.                Before we get all hot and bothered, consider the numbers
   In practice, markets have been willing to accept a six- to     are always revised. October was revised up to $95.5 from
seven-percent deficit-to-GDP ratio because the U.S. is such       $85.3 billion, itself a revision from $82.3 billion, so we have
a dandy place to invest: It has size, variety, liquidity, legal   two rounds of revisions to bring the $15.6 billion up to a
safeguards, relative absence of government regulation, and        higher number.
so on.                                                               All the same, it’s unlikely to be revised to the trade deficit
   Still, the countervailing capital flows that “fund” the cur-   level and it is therefore an appalling shortfall. What is the
rent account deficit may be drying up. The net portfolio          cause? In a nutshell, it is mostly due to a record net outflow
flow in the monthly “Treasury International Capital                                                              continued on p. 24
System” (TICS) report does not literal-
ly pay for the trade deficit, which is
the main component of the current
account deficit.
   Trade is almost entirely financed by
banks and exporter credit. It is there-
fore inaccurate to say that foreign pur-
chases of American stocks and bonds
“fund” the trade deficit. But since the
balance of payments is an accounting
convention and balance is achieved
via capital inflow, it seems that way.
And large capital inflows in 2006 did
serve to pound down the crash theo-
rists. The current account deficit was a
horrific $860 billion — but foreign
investment in U.S. securities was $896
billion.
   There are two chinks in the counter-
vailing capital-flow argument. The
first is Chinese government plans to
re-allocate $300 billion from official
reserves into two agencies that will
make direct investments in foreign
and domestic companies and stock-
piles of strategic commodities. This is
about 20 percent of total reserves of $1
trillion, so it’s small potatoes — and
will be easily replaced by new
reserves within one year. Some por-
tion of that may go to U.S. equities or
corporate bonds, and will still be con-

CURRENCY TRADER • March 2007                                                                                                     23
     ON THE MONEY continued

 Other Barbara Rockefeller articles:
 “Indicator failure and scientific analysis,” Currency Trader, February 2007.
 This discussion of market biases and fallacies provides a more rigorous way
 to think about trading.                                                             of foreign investment from U.S. equi-
                                                                                     ties ($11.6 billion in December after
 “Reserve diversification, Part II,” Currency Trader, January 2007.
                                                                                     being buyers in November of $7 bil-
 What is the U.S. doing to ensure the Chinese government will not alter the
                                                                                     lion), and a record U.S. investment in
 $700 billion it has in U.S. dollar reserves?
                                                                                     foreign securities, $18.9 billion in for-
 “Charts are not enough,” Currency Trader, December 2006.                            eign equities and another record $28.4
 Breaking down price action in light of the news.                                    billion in foreign fixed income. Not
                                                                                     only have foreigners decided to find
 “When will the yen go to the moon?” Currency Trader, October 2006.
                                                                                     greener equity pastures outside the
 The fundamentals are all pointing toward an up move in the Japanese yen.
                                                                                     U.S., the U.S. investor has learned the
 So what’s it waiting for?
                                                                                     diversification lesson at last.
 “Why is everybody losing money in forex?”                                              By country, biggest investors were
 Currency Trader, September 2006.                                                    the UK, fronting for petrodollars
 Despite unprecedented liquidity, professional currency managers have had a          ($15.9 billion), and China ($14.7 bil-
 rough go of it in 2005 and 2006. Has something changed in the forex world?          lion). Aside from countries adding to
                                                                                     U.S. government and agency paper
 “Gauging trader commitment,” Currency Trader, August 2006.
                                                                                     because of foreign exchange market
 Is this a good breakout or a false move? The Commitment of Traders report
                                                                                     intervention (China, S. Korea, and
 can help currency traders fill in some of the holes left by the absence of tradi-
                                                                                     Taiwan), other official entities bought
 tional volume data in forex.
                                                                                     less, including the Middle East
 You can purchase and download past articles at                                      petrodollar accounts managed out of
 www.activetradermag.com/purchase_articles.htm.                                      London. Norway, through its
                                                                                     Petroleum Fund, was a net seller of
                                                                                     $4.1 billion of U.S. Treasuries. This is
                                                                                     an unintended consequence of lower
                                                                                     oil prices. Private buyers, meanwhile,
                                                                                     were also net sellers. Together the
                                                                                     Cayman Islands, Bahamas, and
                                                                                     Bermuda, considered the domicile of
                                                                                     private investors, sold $17.10 billion
                                                                                     in U.S. Treasuries.
                                                                                        The private investors are critical,
                                                                                     since we cannot expect official
                                                                                     reserves to rise by the full amount of
                                                                                     the U.S. deficit and every penny of
                                                                                     reserves to be recycled back to the
                                                                                     U.S. Private investors have a choice to
                                                                                     accept higher risk in return for higher
                                                                                     yield in emerging markets, junk
                                                                                     bonds, and commodities. The U.S.
                                                                                     may have the biggest game, but it’s
                                                                                     not the only game.
                                                                                        “Portfolio” funds sound sedate and
                                                                                     these asset categories are named
                                                                                     “long-term,” but in practice, this is
                                                                                     fairly hot money. It takes no more
                                                                                     than three to five days to sell a stock
                                                                                     or bond position and withdraw funds
                                                                                     from just about anywhere in the
                                                                                     world and wire it to a safe haven if
                                                                                     one is needed. We saw the dollar get
                                                                                     large safe-haven inflows when North
                                                                                     Korea was misbehaving last fall, for


24                                                                                           March 2007 • CURRENCY TRADER
                                  FIGURE 1 — YEN MEGA-TRIANGLE

                                   The long-term chart of the dollar/yen pair reveals a massive consolidation pattern. Traders
                                   are wondering what catalyst might kick the yen into a higher gear.


example. But we can hardly
count on “geopolitical” risk
to save the U.S. balance of
payments. The U.S. trade
deficit is like the super-
tanker that takes miles and
miles to turn around in
mid-ocean — $764 billion in
2006 and rising.
   The foreign exchange
market barely burped when
the capital flow report was
announced. The timing was
lucky — the Friday before a
three-day weekend in the
U.S. (President’s Day). It’s
curious that it’s not a major
topic     of    conversation
among analysts and traders
— so far. But if the next
report comes in similarly
short, look for the dollar to     Source: Chart by MetaStock, data from eSignal
get the collywobbles.
   We will know that nausea
has turned into dollar-selling panic if
the yen joins the crowd, since the rea-
sons for the yen to remain weak are so
solid. A rising yen would be strong
evidence of a major dollar rout.
Strangely enough, it could be a tech-
nical point coinciding with the capital
flow story that could set off the move.

The Japanese canary
Figure 1 is a monthly yen chart going
back to 1985 that shows the overall
dollar-yen super-downtrend. It is
punctuated by serious corrective
countertrend moves, like the one in
1995-98 that took the yen from 80.00
to 138.00. But on the whole, we see
lower highs and higher lows that
form the support and resistance lines
of a triangle. The dollar’s upside is
capped by the top of the linear regres-
sion channel at 133.00-135.00 by mid-
2007, or by the additional parallel
resistance line at around 127.00.
   Traders look at a chart like this and
see dwindling volatility and lesser
degrees of trend. We see a cap on the
dollar’s rise against the yen and it
                       continued on p. 26


CURRENCY TRADER • March 2007                                                                                                     25
   ON THE MONEY continued



reminds us that “If you can’t buy it, sell it.”                 shows up. That is, when the Fed has to raise interest rates to
   By mid-June, we will have had four more TICS reports,        the point where rates at the long end — which can be influ-
which are normally delivered on the 15th-17th of each           enced by the Fed only indirectly — rise enough to induce
month (you can get the exact schedule as well as more           the marginal buyer. But so far, foreigners are still taking 30
detail at www.ustreas.gov/tic). Unless foreign investors        to 40 percent in the quarterly refunding, and with the U.S.
change their minds about the U.S. market, or U.S. investors     budget deficit and funding requirements falling, we may
stop diversifying into foreign markets, we don’t see a rea-     not see a shortfall for official U.S. government paper by for-
son for the capital flows to resume at an adequate level to     eign official government entities.
fund the trade deficit. This could mean the dollar debacle is      The problem lies with equities and private investors. The
finally upon us after having been forecast for so many          only solution to “excessive” outflow is regulation, such as a
years. And it will be the yen that is the canary in the coal    tax on foreign investment. This is old-fashioned and seems
mine warning us to flee for the hills.                          so unlikely in today’s American political environment as to
                                                                be impossible. That doesn’t mean politicians won’t talk
Filling in the picture                                          about it. By the time they are talking about it, though, it’s
Two final points: Capital inflow can also take the form of      already too late to head it off at the pass, and we will be in
direct investment, i.e., foreigners buying entire companies,    full-blown crisis mode.
shopping centers and office buildings, and other hard assets       What are the odds? Nobody knows, because nobody can
directly instead of through the medium of a “security.” At      forecast the capital flow report. One bad report should not,
some point, the dollar becomes so cheap that these assets       perhaps, be the foundation of a scenario on which to bet
are irresistible. That is what happened in the mid-90s — a      serious money. But keep an eye peeled for the mid-March
vast inflow of direct investment, and it can indeed save the    TICS report (for January flows). If it’s bad again, we’d start
dollar even if portfolio inflows continue ever weaker.          building a long position in yen.
   Second, we always joke that we know we have a dollar
crisis if the U.S. Treasury holds an auction and nobody         For information on the author see p. 6.
               ADVANCED STRATEGIES




                Comparing the
           major euro cross rates
               The interplay between the British pound and Swiss franc shed light on the impact
                                       of the euro and the future of currency rates.

                                                     BY HOWARD L. SIMONS




   H             ere’s an unanswerable question: How will
                 future economic historians regard those
                 countries in Europe that chose to remain
                 outside of the euro?
     Several of the non-participants, such as Denmark and
   Norway, have currencies not considered to be among the
   “majors.” Other non-participants, principally Eastern
                                                                      remained outside of the euro. Neither is expected to join in
                                                                      the foreseeable future, the British for cultural reasons and
                                                                      the Swiss to maintain their vaunted neutrality. Both cross-
                                                                      rates, the British pound/euro (GBP/EUR) and Swiss
                                                                      franc/euro (CHF/EUR), are critical to the economic success
                                                                      and financial stability of both countries. A visit to either,
                                                                      where retail prices are posted in euros (and dollars) along-
   European states such as Poland and Hungary, hope to join           side pound and franc prices, confirms this immediately.
   the club some day.                                                    The consolidation of 12 currencies into the euro removed
     Two non-participants — the UK and Switzerland — have             66 different currency pairs from the interbank market.
   currencies commonly regarded as majors but have                    We will pass on the question of whether the world
                                                                                       is better or worse without Finnish mark-
FIGURE 1 — THE GREAT SWISS MONETARY DIVERGENCE                                         ka/Portuguese escudo cross-traders, but
                                                                                       we will note the combined absence of all
Since the January 1999 advent of the euro, the Bank of England and the European
                                                                                       these cross-rate trades did lead to a pro-
Central Bank have kept their monetary policies tightly aligned, while the Swiss
                                                                                       nounced drop in global currency volatility
National Bank’s reduction of their target LIBOR from 0.75 to 0.25 percent in March
2003 pushed the Swiss FRR well above the UK and Eurozone levels.                       (see “Currency trends and volatility,”
                                                                                       Currency Trader, November 2006).
                                                                                          The GBP/EUR and CHF/EUR are the
                                                                                       two principal trades remaining within the
                                                                                       euro bloc, the currency world’s counter-
                                                                                       point to the U.S. dollar bloc (see “The dol-
                                                                                       lar index and ‘firm’ exchange rates,”
                                                                                       Currency Trader, December 2005). What
                                                                                       drives them, and what information can we
                                                                                       derive from their movements?

                                                                                     Non-parallel universes
                                                                                     The expected interest-rate differential
                                                                                     between two currencies is an excellent
                                                                                     starting point for examining a currency
                                                                                     cross-rate. The key metric for a currency is
                                                                                     the forward rate ratio (FRR) between six
                                                                                     and nine months, which is the rate at
                                                                                     which we can lock in borrowing for three
                                                                                     months beginning six months from now.
                                                                                        The FRR today provides a tradable inter-
                                                                                     est-rate expectation applicable to the deci-

   28                                                                                             March 2007 • CURRENCY TRADER
                                            FIGURE 2 — DIFFERENTIAL INTEREST RATE EXPECTATIONS
                                                       BETWEEN CHF AND EUR
                                             In 2004 the CHF/EUR eventually collapsed under the weight of looser Swiss
                                             monetary policy — weakness that persisted through late 2006, even though the
                                             Swiss FRR is flattening relative to the Eurozone FRR.



sion whether to roll a three-month non-
deliverable forward for another three
months starting three months from now.
The more an FRR exceeds 1.00, the
steeper the yield curve is over that seg-
ment and, by extension, the looser that
country’s monetary policy is.
   While the Swiss long have enjoyed a
reputation for fiscal probity, they have
been as willing as anyone to engage in
monetary stimulus in recent years.
Comparing the FRRs for the euro (EUR),
British pound (GBP), and Swiss franc
(CHF) since the January 1999 advent of
the euro reveals the Bank of England
(BOE) and the European Central Bank
(ECB) have kept their monetary policies
tightly aligned (Figure 1). The most
notable exception was in late 2005 and
                                            FIGURE 3 — THE CHF / EUR CROSS-RATE
early 2006 when the ECB maintained a
looser monetary policy than the BOE.         The volatility reflecting the cost of buying options on the CHF has declined
   Not so for the Swiss National Bank        steadily since the 2003 rate cut — which implies there is little fear the CHF will
(SNB). The reduction of their target         strengthen anytime soon.
LIBOR from 0.75 to 0.25 percent in
March 2003 — three months before the
Federal Reserve cut the federal funds
rate to 1 percent — propelled their FRR
higher and well over comparable levels
in the UK and Eurozone. Their increase
of the target LIBOR in June 2004 to 50
basis points matched the Federal
Reserve’s move in timing and size, and it
started a very rapid change in their FRR.

The Swiss-euro cross
Any discussion of the EUR’s long-term
history has to factor in one non-econom-
ic reason for its weakness in 2000-2001:
the sale of “legacy” currencies hidden
from the various national tax collectors
prior to the introduction of cash euros in
2002. This so-called “mattress trade”
made the CHF/EUR unnaturally strong
during those years.                                            else held equal, its currency should weaken.
   The difference in two countries’ FRRs can be used to           All else seldom is held equal, however. The Swiss FRR
compare their monetary policies. A country whose FRR is        has exceeded its Eurozone counterpart since late 2001
greater than another’s has a looser monetary policy and, all                                                   continued on p. 30


CURRENCY TRADER • March 2007                                                                                                  29
     ADVANCED STRATEGIES continued




FIGURE 4 — DIFFERENTIAL INTEREST RATE EXPECTATIONS                                 (Figure 2), but it did not break its trend
           BETWEEN GBP AND EUR
                                                                                   support (dashed line) until the March
 Although British monetary policy tightened relative to the Eurozone (and the      2003 Swiss rate cut. The CHF/EUR
 FRR differential fell into negative territory), the GBP/EUR rate stayed in a      then collapsed under the weight of
 trading range instead of strengthening.                                           looser Swiss monetary policy, and that
                                                                                   weakness persisted through late 2006
                                                                                   even though the Swiss FRR is flatten-
                                                                                   ing relative to the Eurozone FRR. It
                                                                                   will take a renewed tightening of Swiss
                                                                                   monetary policy to change this.
                                                                                      Will this happen anytime soon? The
                                                                                   message from the cross-rate options
                                                                                   market is, “No.” The cost of buying
                                                                                   options on the CHF has declined
                                                                                   steadily for EUR holders since the 2003
                                                                                   rate cut — which implies EUR holders
                                                                                   who have borrowed the CHF and
                                                                                   swapped it into EUR have no fear the
                                                                                   CHF will strengthen anytime soon. Of
                                                                                   course, these same CHF borrowers are
                                                                                   increasing the risk of the underinsured
                                                                                   event — a sudden rise in the CHF — by
                                                                                   creating a path of greatest anxiety in
                                                                                   that direction (Figure 3).

FIGURE 5 — THE GBP / EUR CROSS-RATE                                                The pound-euro cross
                                                                                   The FRR relationship between the GBP
The volatility of GBP forwards has declined since late 2000 (interrupted only by   and the EUR has been markedly differ-
a May 2002-May 2003 rebound), suggesting EUR holders believe the trading
                                                                                   ent than that between the CHF and
range will persist.
                                                                                   EUR. Once the mattress trade ended
                                                                                   and the FRR differential remained
                                                                                   above zero into mid-2004, the
                                                                                   GBP/EUR rate fell as expected (Figure
                                                                                   4). After mid-2004, British monetary
                                                                                   policy tightened relative to that of the
                                                                                   Eurozone and the FRR differential fell
                                                                                   into negative territory. However, the
                                                                                   GBP/EUR rate remained in a trading
                                                                                   range rather than strengthening. And
                                                                                   while the FRR differential remained
                                                                                   negative, it was far from static: It fell
                                                                                   sharply into the start of 2006 and then
                                                                                   rebounded rapidly thereafter, all with-
                                                                                   out a material and noticeable effect on
                                                                                   the GBP/EUR rate.
                                                                                      Just as the volatility of CHF forwards
                                                                                   fell continuously after early 2003, the
                                                                                   volatility of GBP forwards also has fall-
                                                                                   en since late 2000, interrupted only by a


30                                                                                        March 2007 • CURRENCY TRADER
                                             FIGURE 6 — BOND YIELDS HAVE CONVERGED

                                             By late 2006, 10-year British, Eurozone, and Swiss bond yields had converged.

May 2002-May 2003 rebound (Figure
5). EUR holders appear convinced the
trading range will persist, as if
ordained by some semi-official policy.

Capital market horizon
Currency exchange rates are more than
simple interest-rate differentials. Two
other factors come into play here, one
relevant and one not particularly so.
   Trade flows between the UK,
Switzerland, and the Eurozone are not
in the sort of persistent imbalance
seen, say, between the U.S. and China
or the U.S. and Japan. Accordingly, we
can dismiss this as a major factor in
exchange rates out of hand.
   The relevant factor is returns in capi-
                        continued on p. 32
     ADVANCED STRATEGIES continued




tal markets. Indexing the yields to maturity on Swiss, British,    returns and parallel monetary policies reduces currency
and Eurozone 10-year notes since the January 1999 advent           volatility. This reduced volatility in turn lowers the liquidi-
of the EUR shows there were wide differences well into             ty premium bond investors demand to protect themselves
mid-2002 (Figure 6). These differences widened slightly in         against currency volatility; yield curves around the world
2005 as British yields remained firm and the GBP short-term        have flattened in part because of this factor.
FRR increased relative to that of the EUR, but then con-              This whole state of affairs is rather extraordinary: In a
verged once more. By late 2006, yields at the 10-year hori-        nominally floating exchange-rate world, the construction of
zon had converged. If returns on capital are similar and the       the EUR led to a de facto return to the stable exchange rates
mobility of labor and other factors of production through-         prevailing prior to the dissolution of Bretton Woods in the
out Europe is high, why should currency exchange rates be          late 60s and early 70s.
volatile on either a realized or an implied-forward basis?            The “firm” exchange-rate environment predicted in the
   The harmonic convergence of asset returns, currency             December 2005 article is, in fact, coming to pass.
volatility, and monetary policies creates something of a vir-
tuous cycle in European markets. The convergence of asset          For information on the author see p. 6.




                                                   Related reading
                                                  Other Howard Simons articles:

 “Mexican peso: Who’s your padre?”                                 “Of commodities and currencies”
 Currency Trader, February 2007.                                   Currency Trader, July 2006.
 The peso is one of several “emerging currencies” that have        Analyzing historic market relationships reveals some inter-
 been gaining popularity. Find out about the key factor that       esting facts about movements in many so-called “commodity
 has propped up the currency — and which could disappear           currencies.”
 in a flash.
                                                                   “The yen carry trade, currencies, and U.S. bonds”
 “The new iron cross”                                              Currency Trader, June 2006.
 Currency Trader, January 2007.                                    The latest source of anxiety for bond traders has some sur-
 The long history of the D-mark/pound and now the                  prising connections to the currency market. Find out the
 euro/pound offers many lessons about economic policies            story behind U.S. Treasuries, the Japanese yen, and the
 and currency fluctuations.                                        Chinese yuan.
 “The pros make it look hard”                                      “The euro index: The dollar index meets its match”
 Currency Trader, December 2006.                                   Currency Trader, May 2006.
 Are currency traders making life unnecessarily difficult for      A look at the development of a viable — and tradable —
 themselves?                                                       euro index.
 “Currency trends and volatility”                                  “The index approach to currency risk management”
 Currency Trader, November 2006.                                   Currency Trader, April 2006.
 Interesting insights come from putting currency volatility        Using dollar index futures to hedge non-dollar investments.
 under a microscope.
                                                                   “The yen stands alone”
 “Currencies and conventional U.S. investments”                     Currency Trader, March 2006.
 Currency Trader, October 2006.                                    The usual rules of the currency world haven’t necessarily
 The financial media often reports on moves in the stock and       applied to the Japanese yen. Will that continue to be the
 bond markets vis-à-vis currency fluctuations, but these rela-     case?
 tionships might not be what you expect.
                                                                   Howard Simons: Advanced Currency Concepts, Vol. 1
 “What does the dollar really affect?”                             A discounted collection that includes many of the articles list-
 Currency Trader, September 2006.
                                                                   ed here.
 Find out how stocks, gold, and other markets actually
 respond to changes in the dollar.                                 You can purchase and download past articles at
                                                                   www.activetradermag.com/purchase_articles.htm.
 “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.



32                                                                                                  March 2006 • CURRENCY TRADER
 3 article collections
     Thom Hartle Strategy and Analysis collection, Vol. 2

              Marc Chandler's Macro View collection

                   Options Trade Journals, Vol. I




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             TRADING STRATEGIES


                                                                             FIGURE 1 — POUND CHALLENGES
                                                                                         LONGTIME HIGHS

Deciphering the                                                              The GBP/USD rate has pushed to levels not
                                                                             seen since September 1992.


British pound
The pound-dollar rate edged up to a nearly 15-year
high in January. Analyzing its daily and intraday per-
formance over the past year provides an idea of how
this currency pair operates.

         BY THOM HARTLE
                                                                             Source: TradeStation




W
                  ith an early-year run that took it to its high- pulled back a little and was trading around 1.9606.
                  est level vs. the dollar since the early 90s,      The following review of British pound/U.S. dollar
                  the British pound has emerged from the          (GBP/USD) price characteristics is based on data from Feb.
                  continental shadow of the euro and is bask-     1, 2006 through Jan. 31, 2007. Overall, the trend was up dur-
ing in the attention of forex traders around the globe.           ing this period, but there were also lengthy sideways and
  Its traditionally choppy trading notwithstanding, the           countertrend moves.
pound gained approximately 15 percent from April 2006 to             During the first quarter of 2006, GBP/USD traded below
the Jan. 23, 2007 high of 1.9914 (Figure 1). By March 1, it had   1.7300, but in January 2007 the pair closed over 1.9800 for
                                                                                        the second month in a row (Figure 2).
                                                                                        From April to mid-May 2006, the pair
FIGURE 2 — DAILY GBP/USD
                                                                                        traded from below 1.7300 up to and
Although price action has been choppy since the April-May 2006 run-up, the              over 1.8900. Then a broad trading range
pound/dollar rate kept adding to its gains, closing above 1.9800 in both
                                                                                        (with a bullish bias) developed: A num-
December 2006 and January 2007.
                                                                                        ber of times the pair edged above 1.8900
                                                                                        and closed above 1.9100, only to see
                                                                                        sellers come in and take the market
                                                                                        back down.
                                                                                           The last pullback took the GBP/USD
                                                                                        pair below 1.8600 in October 2006.
                                                                                        From there, the trend reasserted itself
                                                                                        again when the market started an
                                                                                        advance that peaked just above 1.9800
                                                                                        by Dec. 1.
                                                                                           The 12-month study period from Feb.
                                                                                        1, 2006 to Jan. 31, 2007 contains 260
                                                                                        trading days. The analysis explores ten-
                                                                                        dencies and patterns in the GBP/USD’s
                                                                                        daily range, close-to-close changes, and
                                                                                        up-closing vs. down-closing days.
                                                                                           A second, intraday study uses 60-
                                                                                        minute bars from Dec. 1, 2006 through
                                                                                        Jan. 31, 2007. This analysis characterizes
                                                                                        the typical hourly price behavior and
                                                                                        identifies the most volatile portion of
 Source: CQGNet (www.cqg.com)
                                                                                        the 24-hour trading session.


34                                                                                              March 2007 • CURRENCY TRADER
                                            FIGURE 3 — DAILY RANGES SORTED LOWEST TO HIGHEST
                                            The smallest daily range was 0.0025 points, which occurred on April 14, 2006.
                                            The largest daily range (0.0325 points) occurred less than a month later on May
                                            11, 2006.
Daily range statistics
Figure 3 shows the ranges of daily
GBP/USD bars sorted from lowest to
highest. The average range was 0.0134
points while the median range was
0.0128 points — fairly consistent, but
indicating a few outliers pulled the
average range above the median
range. The smallest range, 0.0025
points, occurred on April 14, 2006; the
largest daily range was 0.0325 points
on May 11, 2006.
   Figure 4 shows the distribution of
the daily ranges. The horizontal axis
divides the daily ranges into different-
sized categories and the vertical axis
shows how many daily ranges
occurred in each category. For exam-        FIGURE 4 — DAILY RANGE DISTRIBUTION
ple, the vertical bar labeled “0.0100”
                                            The daily ranges tended to be between 0.0061 points and 0.0180 points
(second from the left of the tallest bar)
represents the daily ranges that were
greater than 0.0080 points up to and
including 0.0100 points (i.e., 0.0081
through 0.0100). There were 35 daily
ranges that fell into this category. The
bar immediately to the left (“0.0080”)
represents the daily ranges from
0.0061 through 0.0080 points; 25 days
fell into this category.
   The four categories from 0.0100
through 0.0160 contain the greatest
concentration of ranges but overall, 77
percent of the ranges were between
0.0061 through 0.0180 points (the
                       continued on p. 36



 Currency characteristics: GBP/USD
 Insights from the Feb. 1, 2006 through Jan. 31, 2007 review of the British pound/U.S. dollar:

 1. The average daily range was 0.0134 points. The range was between 0.0060 and 0.0180 points 77 percent of the
    time, and it exceeded 0.0200 points only 14 percent of the time.

 2. Eighty-one percent of the close-to-close price changes were between -0.0100 and +0.0100 points. The
    close-to-close changes exceeded +0.0100 points 13 percent of the time and the close-to-close change exceeded
    -0.0100 points to the downside just five percent of the time.

 3. If the GBP/USD pair traded more than 0.0050 points below the previous day’s close, it closed up for the day just
    11 percent of the time.

 4. If the GBP/USD pair traded 0.0050 points above the previous day’s high, it closed down for the day nineteen
    percent of the time.

 5. Intraday analysis from Nov. 1, 2006 through Dec. 29, 2006 showed the average 60-minute range (for all bars)
    was 0.0047 points (median 0.0041 points). The 7:00 hour (7 to 8 a.m. CT) had the largest average 60-minute
    range.


CURRENCY TRADER • March 2007                                                                                                  35
     TRADING STRATEGIES continued


 FIGURE 5 — DAILY CLOSE DISTRIBUTION
                                                                                     largest one-day net close-to-close loss
 Eighty-one percent of the daily close-to-close changes were between 0.0100          was -0.0221 points (Jan. 3, 2007), while
 and -0.0100 points.
                                                                                     the largest one-day close-to-close gain
                                                                                     was 0.0243 points (April 28, 2006).
                                                                                        The greatest number of close-to-
                                                                                     close differences fell in the 0.0025 cate-
                                                                                     gory, which represents close-to-close
                                                                                     changes from 0.0001 up to and includ-
                                                                                     ing 0.0025 points.
                                                                                        Eighty-one percent of the close-to-
                                                                                     close differences were between -0.0100
                                                                                     and +0.0100 points. The close-to-close
                                                                                     change exceeded 0.0100 points on the
                                                                                     upside only 13 percent of the time and
                                                                                     exceeded -0.0100 points to the down-
                                                                                     side only five percent of the time.
                                                                                        Interestingly, the market closed up
                                                                                     only 52 percent of the time despite the
                                                                                     pound’s overall bull move during the
                                                                                     analysis period.

 FIGURE 6 — ADJUSTED DAILY BARS FOR UP-CLOSING DAYS
                                                                                     Up-closing vs.
 On days that closed up, the low fell below the previous close -0.100 points or      down-closing days
 more only four times.                                                                Figure 6 shows the daily bars that
                                                                                      closed above the previous day’s close,
                                                                                      adjusted so the previous day’s close is
                                                                                      used for each day’s opening price (rep-
                                                                                      resented by the 0.000 line); this high-
                                                                                      lights how much of each bar’s range
                                                                                      was above or below the previous close.
                                                                                      There were 136 days the market closed
                                                                                      up. The lows on these days were usu-
                                                                                      ally no more than -0.0050 below the
                                                                                      previous close.
                                                                                         Figure 7 shows the distribution of
                                                                                      the lows on days the GBP/USD rate
                                                                                      closed higher. The low was between
                                                                                      -0.0030 and zero points below the pre-
                                                                                      vious close (the -0.0030 to the 0.0000
                                                                                      categories) 68 percent of the time. The
                                                                                      market dropped by more than -0.0100
                                                                                      points or more below the previous
0.0080 through 0.0180 categories). Only 13.5 percent (35         day’s close and closed up on the day only four times.
days) of ranges exceeded 0.0200 points and only 3.8 percent         The market gapped up on the open and did not trade in
(10 days) were 0.0060 points or smaller.                         negative territory three times. The largest intraday decline
   Next, we’ll look at the pound/dollar rate tendencies on a     from the previous close was -0.0163 points.
daily close-to-close basis.                                         Figure 8 is similar to Figure 6 except it shows days the
                                                                 GBP/USD rate closed down. The market usually traded no
Close-to-close changes                                           more than 0.0050 points above the previous close on days it
Figure 5 shows the distribution of close-to-close differences.   closed lower. There was only one instance of the market
Each category represents a 0.0025-point range — i.e., the        trading more than 0.0100 points above the previous close
-0.0200 category (second from the left) shows the number of      and reversing to close lower on the day.
close-to-close changes that were between -0.0226 up to and          Figure 9 shows the distribution of the highs for the 122
including -0.0200.                                               down-closing days in the analysis period. The high was
   The GBP/USD rate closed unchanged just twice. The             between 0.0001 to 0.0040 points above the previous close 68


36                                                                                           March 2007 • CURRENCY TRADER
                                             FIGURE 7 — DISTRIBUTION OF LOWS FOR UP-CLOSING SESSIONS
                                             On days the market closed up, the low was usually (68 percent of the time)
                                             between -0.0001 and -0.0030 points below the previous close.

percent of the time. The market failed
to trade in positive territory only once,
and there was only one instance when
the market traded as high as +0.0147
points above the previous close (far
right, 0.0150 category) and still closed
down for the day.
   The next part of the analysis looks
at intraday price action.

Intraday analysis: When
does the most price action
occur?
The following analysis of 60-minute
bars in the GBP/USD rate uses a 24-
hour trading session based upon
Central Time (CT). Each Friday, the          FIGURE 8 — ADJUSTED DAILY BARS FOR DOWN-CLOSING DAYS
market closes at 15:00 (3:00 p.m. CT)        The spike high is a day the GBP/USD rate reversed direction after being up
and reopens at 16:00 (4:00 p.m.) on          nearly 0.0150 points. The remainder of the days had highs that were less than
Sunday. On all other days, the close is      0.0100 points above the previous day’s close.
at 23:59 (11:59 p.m.) and reopens at
0:00 (midnight).
   Figure 10 shows the 60-minute bars
from Dec. 1, 2006 through Jan. 31,
2007. The gap toward the far right side
in the top panel is due to the
Christmas holiday. The peak in the
bottom panel represents the previous-
ly mentioned January high of 1.9914.
   The goal of the intraday analysis is
to identify the time of the day when
the market is the most volatile — i.e.,
when it is moving the most and offers
the best chance of profitability.
   First, the high-low range for each
60-minute bar was calculated and the
bars were sorted by time (Figure 11).
Next, both the average and median            FIGURE 9 — DISTRIBUTION OF HIGHS FOR DOWN-CLOSING SESSIONS
ranges were determined for each hour.        The majority (68-percent) of the time on down-closing days, the high was
The median is especially helpful             0.0001 to 0.0040 points above the previous day’s close.
because it represents the center point
of each range; if the average is very far
above or below the median, then out-
liers have skewed the data.
   The highest average 60-minute
range occurred during the 7:00 hour
(7-8 a.m. CT): The average was 0.0047
points while the median was 0.0041
points, implying the presence of a few
larger ranges that skewed the average
higher. However, the 9:00 hour (9-10
a.m.) had the highest median range
(and the second-highest average
range). The median range was 0.0043
                        continued on p. 38


CURRENCY TRADER • March 2007                                                                                                 37
     TRADING STRATEGIES continued

FIGURE 10 — INTRADAY PRICE ACTION: DEC. 1, 2006 THROUGH JAN. 31, 2007
 The 60-minute bars for the intraday analysis period are shown in three panels.   points while the average was 0.0045
 The gap in the price action is the Christmas holiday.
                                                                                  points. During the 8:00 hour, the aver-
                                                                                  age range was 0.0039 points and the
                                                                                  median was 0.0035 points. Not sur-
                                                                                  prisingly, this period marks the major
                                                                                  overlap between the U.S. and
                                                                                  European trading sessions. (Also, the
                                                                                  1:00 to 3:00 hours, which represent
                                                                                  the early part of the European trading
                                                                                  session, have relatively large ranges
                                                                                  — the medians are greater than 0.0030
                                                                                  points and the averages are above
                                                                                  0.0035 points.) Volatility drops off
                                                                                  from 14:00 (2 p.m.) onward.
                                                                                     Figure 12 shows the individual
                                                                                  ranges for the three high-activity
                                                                                  hours (7-10 a.m.). As expected, the
                                                                                  7:00 hour has a small collection of
                                                                                  exceptionally large ranges relative to
                                                                                  the other two periods — hence its
                                                                                  high average. The range exceeded
                                                                                  0.0080 points four times during this
                                                                                  hour, something that happened only
                                                                                  once in the 8:00 hour and twice in the
                                                                                  9:00 hour. However, the 9:00 ranges
                                                                                  were consistently larger — hence the
                                                                                  period’s larger median.
                                                                                     Figure 13 shows the distribution of
                                                                                  the ranges for the three high-activity
                                                                                  hours. The hourly range was less than
                                                                                  0.0050 points 82-percent of the time; it
                                                                                  was larger than 0.0080 points only
                                                                                  eight times. The greatest number (19)
                                                                                  of hourly ranges was from 0.0026
                                                                                  points up to and including 0.0030
                                                                                  points (the 0.0030 category).

                                                                                  Pound in the round
                                                                                  Among the tendencies this analysis
                                                                                  revealed was the pound/dollar’s rel-
                                                                                  atively low percentage (given the fact
                                                                                  the pair made a healthy overall gain
                                                                                  during the study period) of higher
                                                                                  closes — 52 percent. On an intraday
                                                                                  basis, the most price volatility
                                                                                  occurred from 7-10 a.m. CT, followed
                                                                                  by 1-4 a.m. CT — periods that, not
                                                                                  surprisingly, represent when the
                                                                                  European and U.S. trading sessions
                                                                                  overlap and the early portion of the
                                                                                  pound/dollar’s “native” trading ses-
                                                                                  sion. “Currency characteristics:
                                                                                  GBP/USD” summarizes the high-
                                                                                  lights of this currency study.
 Source: CQGNet (www.cqg.com)
                                                                                     Statistical analysis is the starting


38                                                                                      March 2007 • CURRENCY TRADER
                                          FIGURE 11 — 60-MINUTE BARS SORTED BY TIME
                                          There are three peak 60-minute periods by average range: the 7:00, 8:00, and
                                          9:00 hours. The 7:00 hour has the biggest difference between the average and
                                          the median range values.
point for developing trading proce-
dures based on quantifiable market
behavior. This type of analysis can be
a guide to the range of market behav-
ior that can occur going forward,
which is what traders need to focus
on. Because of this, such analysis
should be performed on a regular
basis.

For information on the author see p. 6.




 Related reading
 “Day trading the FX market:
                                          FIGURE 12 — 60-MINUTE RANGES, 7 A.M. TO 10 A.M.
 A different approach to
 the pound”                               The peak readings occur in the 7:00 hour, but the 9:00 hour has the second-
 Active Trader, June 2004.                highest values of the three 60-minute periods.
 Opening-range breakout tech-
 niques have long been favorites of
 intraday stock index traders. A sim-
 ilar technique can be used in the
 currency market to capitalize on
 price moves in the British pound.

 “Dollar-Canada by the numbers”
 Currency Trader, January 2006.
 As 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.

 “Euro/yen: Tips and tendencies”
 Currency Trader, December 2006.          FIGURE 13 — DISTRIBUTION OF 7-10 A.M. HOURLY RANGES
 Euro/yen by the numbers: Stats
 and tendencies for short-term forex      The majority (82 percent) of the ranges are between 0.0016 and 0.0050 points.
 players.

 “Breaking down the euro”
 Currency Trader, November 2006.
 Studying the euro’s daily and intra-
 day performance statistics offers
 guidelines for systematic and dis-
 cretionary traders.

 You can purchase and
 download articles at
 www.activetradermag.com/
 purchase_articles.htm




CURRENCY TRADER • March 2007                                                                                              39
           CURRENCY BASICS


                             The Eurozone
     The Eurozone is comprised of all the countries in Europe that use the euro as their currency.
                        But who’s not in the Eurozone is just as important as who is.

                                           BY CURRENCY TRADER STAFF




A
              lthough the creation of the Eurozone in 1999 is   Central Bank sets the interest rate and decides monetary
              considered to be a political move by some and     policy for the entire Eurozone. And while individual coun-
              an economic move by others, there is no ques-     tries still track and report economic data such as unem-
              tion it dramatically changed the world’s cur-     ployment, GDP, etc., those statistics are also kept for the
rency landscape.                                                Eurozone as a whole.
   The Eurozone consists of 13 members of the 27-country
European Union (EU) that use the euro as their currency.
The euro was launched on Jan. 1, 1999, marking the end of,      The euro is the native currency for
among others, the Deutsche mark, the French franc, and the
Italian lira.                                                   more than 480 million people and has
   Eleven countries — Austria, Belgium, Finland, France,
Germany, Ireland, Italy, Luxembourg, Netherlands,               reportedly surpassed the U.S. dollar in
Portugal, and Spain — joined the Eurozone at the outset,
while Greece (2001) and Slovenia (2007) joined later.           terms of its cash value in circulation.
   Monaco, San Marino (quick — find it on a map), and
Vatican City also use the euro, although they are not mem-
bers of the EU. A few other countries also use the euro         Still growing, but some growing pains
because they have no official currency of their own and pre- Eleven more EU countries — Malta, Cyprus, Slovakia,
viously used that of another European country that           Estonia, Lithuania, Bulgaria, Hungary, Latvia, Czech
switched to the euro.                                        Republic, Poland, and Romania — have committed to join-
   As a result, the euro is now the native currency for more ing the Eurozone beginning in 2008 and ending (with
than 480 million people, and the Financial Times reported in Romania) in 2014.
late December the euro has surpassed the U.S. dollar in         There are certain economic requirements a country must
terms of the value of cash in circulation.                   satisfy before being allowed in the Eurozone, most having
   The creation of the Eurozone also eliminated the need for to do with deficits and national debt. Meeting these require-
member countries to have a central bank. The European        ments has proven to be a burden for certain countries and
                                                                                   has caused the delay of some of the
                                                                                   newer countries’ membership.
 TABLE 1 — EUROZONE BRIEF
                                                                                      Nonetheless, the Eurozone contin-
                                                                                   ues to grow, but in examining what
  When it started Officially, in January 1999 with the introduction                impact the member countries might
                   of the euro.                                                    have on the euro, it’s also important to
  Member nations/ Austria, Belgium, Finland, France, Greece, Germany,              discuss who’s not in the Eurozone.
  principalities   Ireland, Italy, Luxembourg, Monaco, Netherlands,                   The UK, Denmark, and Sweden are
                   Portugal, San Marino, Slovenia, Spain, Vatican City (16)        all members of the EU, but have not
  Population                                                                       yet agreed to switch over to the euro.
  represented      480 million                                                     Switzerland has remained independ-
                                                                                   ent of the EU and the Eurozone.
  Commitments      Malta, Cyprus, Slovakia, Estonia, Lithuania, Bulgaria,
                                                                                      Sweden has been the most agreeable
  to join          Hungary, Latvia, Czech Republic, Poland, Romania (11)
                                                                                   to changing currencies, but the most
  Most notable                                                                     recent public referendum — taken in
  non-participants Switzerland, UK, Denmark, Sweden (4)                            2003 — indicated that more than 55
                                                                                   percent of Swedish citizens did not

40                                                                                         March 2007 • CURRENCY TRADER
want to adopt the euro. While the coun-
                                                                     Related reading
try is still considering a currency switch,              “The euro index: The dollar index meets its match”
indications are it won’t happen until the                              Currency Trader, May 2006.
2010 general elections at the earliest.         The launch of tradable euro index futures and options may be the next
   Unlike Sweden, Denmark and the UK                 step in the ascendancy of a new dollar-euro currency regime.
have no stated intention of joining the
Eurozone. As is the case with Sweden,                                  “Breaking down the euro”
the last public referendum in Denmark                              Currency Trader, November 2006.
seeking opinion on the euro resulted in          How far can the euro drop and still close higher on the day? If you’re
a majority of citizens opposing a switch.       trading the EUR/USD rate, this is just one of the stats you should have
   However, whatever decision Sweden                                        at your fingertips.
and Denmark ultimately make, their
inclusion or exclusion will have mini-                        You can purchase and download past articles at
mal effect on the Eurozone economy                            www.activetradermag.com/purchase_articles.htm.
and the value of the euro. The UK, how-
ever, is a different matter.                                    throughout the next few years, the additions are all smaller
   Besides whatever economic benefits are derived from countries and not significant enough to cause a major
switching to the euro, countries for the most part have done change in the way the euro is priced.
it because a single currency is helpful in creating more          A UK or Switzerland adoption of the euro would have a
political integration in Europe. The UK, considering its major impact, but that’s a scenario unlikely to happen any
powerful role in global politics, views any euro adoption time soon.
almost entirely as an economic change, and as
such has adopted rules regarding any possible
elimination of the pound.
   For starters, inclusion in the Eurozone would
have to be approved by Parliament, the British
Cabinet, and the general public via a referendum.
Opinion polls taken in the UK indicate no desire
by the populace to switch to the euro. Many
respondents believe it is important for the UK to
remain independent, both politically and eco-
nomically.
   Considering the UK’s lukewarm interest in
adopting the euro, and the strength of the coun-
try’s currency and economy, it seems unlikely the
British pound will go away any time soon.
   Even more against joining the Eurozone is
Switzerland, which values its independence and
role as the world’s banking leader so much it has
never joined the European Union. While mem-
bership in the EU is still being considered by the
Swiss government, it has already been voted
down by the Swiss people via referendum, and
any near-term change in that scenario is unlikely.
   For a more detailed look at the interplay
between the euro, the British pound, and the
Swiss franc, see “Comparing the major euro cross
rates.”

Effects on the euro
While the Eurozone just added a new member in
Slovenia, and will continue to add members

CURRENCY TRADER • March 2007                    41
            INDUSTRY NEWS


Double your pleasure                                   FIGURE 1 — YEN FALLS AFTER RATE INCREASE

Japan raises                                           The Japanese yen dropped 1 percent over two days — reflected in the
                                                       rally in the dollar-yen rate (USD/JPY) — after the Bank of Japan raised
                                                       interest rates 25 basis points.
interest rates

A           fter ending a multi-year zero-interest
            rate policy in July 2006, Japan raised
            interest rates again in February, 25
basis points to 0.50 percent.
   The Bank of Japan (BOJ), citing economic data
that came in stronger than expected, voted 8-1 to
raise rates to an almost-nine-year high. Japanese
economists had expected a rate raise in 2007, but
were unsure when it would happen.
   A week before the interest-rate change, Japan
announced better-than-expected fourth-quarter
GDP growth of 4.8 percent, the highest rate in
                                                      Source: eSignal
almost three years. The BOJ determined the eco-
nomic expansion would continue, with con-
sumer spending and prices improving.                              The yen reacted to the news by selling off against the U.S.
   Speaking to parliament two days after the rate hike, BOJ dollar (Figure 1; upward movement on the chart indicates
governor Toshihiko Fukui said interest rates would be the dollar strengthening vs. the yen) for two days before
raised gradually to help prolong stable economic growth. leveling off on Feb. 23. The Nikkei 225, Japan’s benchmark
Fukui added that interest rates of 0.5 percent are low, con- stock index, reacted favorably to the news, opening at
sidering the Japanese economy grew at a 2-percent clip in 17,896.60 on Feb. 21 and closing at 18,188.42 — a gain of
2006.                                                          more than 1.5 percent — on Feb. 23.



Bullish or bearish

More currency ETFs hit the market

A          trio of new products are extending the currency
           market’s reach beyond the spot forex and futures
           arenas.
   In late February, PowerShares introduced two new
exchange-traded funds (ETFs) designed to track the move-
                                                                 what’s driving it, and its impact on their investment port-
                                                                 folios, but there haven't been a lot of tools to invest in the
                                                                 dollar’s moves,” says Kevin Rich, chief executive of DB
                                                                 Commodity Services, the firm that manages the ETF.
                                                                    Volume for the two ETFs for the first week of trading has
ment of the U.S. dollar vs. a group of global currencies. The    been much better for UDN, as its average daily volume was
U.S. Dollar Bullish Fund (UUP) and the U.S. Dollar Bearish       more than 31,000 as opposed to 8,000 for UUP.
Fund (UDN) profit from rises and drops in the greenback,            Another currency ETF that began trading in February is
respectively.                                                    the Rydex CurrencyShares Japanese Yen Trust (FXY). While
   The index tracked by the ETFs measures the dollar vs. the     the PowerShares ETFs invest in futures contracts to repli-
euro (which accounts for 57.6 percent of the value of the        cate the movement of the dollar, the yen trust actually
fund), the Japanese yen (13.6 percent), the British pound        invests in the currency.
(11.9 percent), the Canadian dollar (9.1 percent), the Swedish      The FXY has been popular with traders, as it averaged
krona (4.2 percent), and the Swiss franc (3.6 percent).          just more than 300,000 contracts per day in February.
   The ETFs allow traders to trade foreign currencies with-         The FXY adds to Rydex’s suite of currency ETFs, which al-
out setting up a separate futures account. Foreign currency      ready include the euro trust (FXE), the British pound sterling
mutual funds have been around for years, but ETFs gener-         trust (FXB), the Canadian dollar trust (FXC), the Australian
ally have lower fees and are easier to get in and out of.        dollar trust (FXA), the Swiss franc trust (FXF), the Swedish
   “Investors are getting more data on the U.S. dollar,          krona trust (FXS), and the Mexican peso trust (FXM).


42                                                                                            March 2007 • CURRENCY TRADER
                CURRENCY FUTURES
                                                                                                    Managed money: Barclay Trading Group’s
                                                                                                    currency trader rankings for January 2007
                                                                                             Top 10 currency traders managing more than $10 million
                                                                                                  as of Jan. 31, ranked by January 2007 return
Slow but steady                                                                                                                           2007      $ Under
                                                                                                                             January      YTD        mgmt.
for currency traders                                                               Rank Trading advisor                       return     return    (millions)
                                                                                     1. Wooster Asset Mgmt (Portage Fund) 6.19            6.19        10.9
Currency traders are two-for-two so far in 2007 as the                               2. Wallwood Consultants (Forex)           6.06       6.06        11.5
Barclay Currency Traders Index (CTI) in February                                     3. Friedberg Comm. Mgmt. (Curr.)          6.04       6.04        63.9
enjoyed a positive return for the second straight                                    4. DKR Capital (DKR Strat. Currency)      4.17       4.17         56
month.                                                                               5. Alder Cap'l (Alder Global 20)          3.40        3.4        127
   While the index lagged behind others at Barclays                                  6. 24FX Management Ltd                    2.81       2.81        15.2
such as the Agricultural Traders and the Systematic                                  7. MIGFX Inc (Institutional)              2.73       2.73        20.5
Traders indices, it nonetheless was up 0.40 percent on                               8. Appleton Cap'l (Appleton 25% Risk)     2.65       2.65       182.7
the year through February.                                                           9. Tradex Capital Mrkts (Select)          2.44       2.44         50
   The index, which measures currency-based man-                                    10. Spot Forex Mgmt. (Zurich)              2.42       2.42        22.7
aged money programs (either futures or spot forex),
was up 0.05 percent in January.                                                        Top 10 currency traders managing less than $10 million and more than
   The index has had only four years of negative                                              $1 million as of Jan. 31, ranked by January 2007 return
                                                                                     1. High Desert Currency Mgmt                13.82      13.82       2.4
returns since first being calculated in 1987, but two of
                                                                                     2. Spot Forex Mgmt. (Lausanne)               4.98       4.98       2.3
those years were 2005 and 2006. In positive years, the
                                                                                     3. Orbani Fund                               4.32       4.32        3
index has never failed to return less than 2.4 percent,
                                                                                     4. Marek D. Chelkowski (Forex)               4.25       4.25        1
with a composite return of almost 550 percent since
                                                                                     5. MIGFX Inc (Retail)                        4.11       4.11       5.1
1987.
                                                                                     6. Pugliese Capital Mgmt (FX)                2.38       2.38       2.4
   The BTOP FX index (BFI), which measures the
                                                                                     7. Black Flag (Gl. Macro)                    1.85       1.85        2
largest currency trading programs, is down 0.18 per-                                 8. Perreard Partners Investments             0.87       0.87       2.9
cent through February. The index stood at 1,006.08 on                                9. SSgA Absolute Return Currency Fund 0.73             0.73        8.8
Feb. 28, less than two percent from the all-time high                               10. Trident Asset Mgmt. (Gl. Currency)        0.33       0.33        7
of 1,023.64 set in December 2005. The BFI was virtu-
                                                                                   Source: The Barclay Group (www.barclaygrp.com)
ally unchanged in February, falling 0.41 points, or
                                                                                   Based on estimates of the composite of all accounts or the fully funded subset method.
0.04 percent.                                                                      Does not reflect the performance of any single account. PAST RESULTS ARE NOT
                                                                                   NECESSARILY INDICATIVE OF FUTURE PERFORMANCE.

       CURRENCY FUTURES SNAPSHOT                               The information does NOT constitute trade signals. It is intended only to provide a brief synopsis of each market’s
       as of Feb. 26                                           liquidity, direction, and levels of momentum and volatility. See the legend for explanations of the different fields.

  Contract                   Pit      Elec        Exch           Vol          OI           10-day         %          20-day           %         60-day           %    Volatility
                            sym       sym                                                   move         rank         move          rank         move          rank ratio/% rank
Eurocurrency                 EC        6E    CME         168.3       178.8                  1.30%        94%         1.99%          44%         -0.06%          3%    .28 / 48%
Japanese yen                 JY        6J    CME         86.2        313.4                  0.68%        50%         0.42%          10%         -3.69%         94%    .47 / 52%
British pound                BP        6B    CME         77.1        151.5                  0.71%        75%        0.29%           13%         0.65%          16%    .17 / 10%
Swiss franc                  SF        6S    CME         50.0         95.8                  1.37%       100%        1.70%           32%         -2.13%         88%    .31 / 58%
Canadian dollar              CD        6C    CME          37.5       142.6                  0.95%        45%         1.67%          90%         -2.53%         48%    .24 / 40%
Australian dollar            AD        6A    CME         30.2        121.1                  2.27%       100%         2.80%          97%          1.34%         28%    .47 / 83%
Mexican peso                 MP        6M    CME         20.0         70.6                 -0.58%       75%         0.00%            0%         -0.41%         30%    .43 / 35%
U.S. dollar index            DX            NYBOT          2.6         22.7                 -1.36%       100%        -1.30%          39%         0.59%          45%    .17 / 18%
New Zealand dollar           NE   6N         CME          2.2         19.2                  4.34%       100%         2.51%          58%          4.37%         32%    .54 / 97%
Euro / Japanese yen          EJ            NYBOT          1.9         35.8                  0.70%        31%         0.85%          18%         3.77%          64%    .32 / 60%
Note: Average volume and open interest data includes both pit and side-by-side electronic contracts (where applicable). Price activity is based on pit-traded contracts.
LEGEND:                                                                                     sixty 20-day moves; for the 60-day move, the % rank field shows how the most recent 60-
Sym: Ticker symbol.                                                                         day move compares to the past one-hundred-twenty 60-day moves. A reading of 100%
                                                                                            means the current reading is larger than all the past readings, while a reading of 0%
Vol: 30-day average daily volume, in thousands.                                             means the current reading is lower than the previous readings.
OI: 30-day open interest, in thousands.                                                     Volatility ratio/% rank: The ratio is the short-term volatility (10-day standard deviation of
10-day move: The percentage price move from the close 10 days ago to today’s close.         prices) divided by the long-term volatility (100-day standard deviation of prices). The %
20-day move: The percentage price move from the close 20 days ago to today’s close.         rank is the percentile rank of the volatility ratio over the past 60 days.
60-day move: The percentage price move from the close 60 days ago to today’s close.
The “% rank” fields for each time window (10-day moves, 20-day moves, etc.) show the        This information is for educational purposes only. Currency Trader provides this data in
percentile rank of the most recent move to a certain number of the previous moves of the    good faith, but assumes no responsibility for the use of this information. Currency Trader
same size and in the same direction. For example, the % rank for 10-day move shows          does not recommend buying or selling any market, nor does it solicit orders to buy or sell
how the most recent 10-day move compares to the past twenty 10-day moves; for the 20-       any market. There is a high level of risk in trading, especially for traders who use lever-
day move, the % rank field shows how the most recent 20-day move compares to the past       age. The reader assumes all responsibility for his or her actions in the market.

CURRENCY TRADER • March 2007                                                                                                                                                         43
             INTERNATIONAL MARKET SUMMARY
                                                     FOREX (vs. U.S. DOLLAR)
                                                   Current
                                                   price vs.      1-month        3-month         6-month           52-week       52-week     Previous
Rank*     Country       Currency                  U.S. dollar     gain/loss      gain/loss       gain/loss           high          low         rank

     1                  Thai baht                  0.02978          4.67%           8.88%         11.83%           0.03012       0.0252          1

     2                  Brazilian real             0.4826           2.66%           4.19%          2.70%           0.4867        0.4157          3

     3                  New Zealand dollar         0.7057           1.29%           5.25%         10.42%           0.7095        0.5925          9

     4                  Euro                       1.3122           1.25%           1.88%          2.14%           1.3364        1.1822         13

     5                  Russian ruble              0.03812          1.14%           1.33%          1.90%           0.03823       0.03511        10

     6                  Canadian dollar            0.8613           1.14%           -1.51%        -3.75%           0.9148         0.842         12

     7                  Swiss franc                0.8066           0.72%           -0.35%        -0.88%           0.8415        0.7553         16

     8                  South African rand         0.1412           0.50%           1.36%          0.00%           0.1678        0.1253         17

     9                  Chinese yuan               0.1292           0.31%           1.49%          2.78%           0.1292        0.1238          2

 10                     Singapore dollar            0.652           0.25%           1.46%          2.55%            0.654        0.6114          6

 11                     Japanese yen              0.008254          0.24%           -3.14%        -4.06%           0.00917       0.00818        14

 12                     Australian dollar          0.7901           0.06%           2.21%          3.63%           0.7978        0.7014         11

 13                     Hong Kong dollar            0.128          -0.08%           -0.31%        -0.47%            0.129        0.1279          7

 14                     Indian rupee               0.02261         -0.09%           1.03%          4.92%           0.02278       0.02123         4

 15                     Taiwanese dollar           0.0303          -0.49%           -0.49%        -0.79%           0.03197       0.02994         8

 16                     Swedish krona               0.141          -0.77%           -0.70%         1.08%            0.148        0.1251         15

 17                     British pound              1.9531          -1.11%           2.48%          3.28%           1.9915        1.7228          5

 As of Feb. 23 *based on one-month gain/loss

                                                             ACCOUNT BALANCE
 Rank Country               2006         Ratio*     2005        2007+         Rank      Country             2006        Ratio*     2005       2007+
  1   Singapore           38.029         28.5      33.269       39.461         13       Mexico             -0.478       -0.1      -4.789     -1.592
      2   Switzerland     50.737         13.3      50.709       52.852         14       France             -38.648      -1.7      -33.577    -40.111
      3   Russia          120.128        12.3      83.558       124.368        15       India              -17.569      -2.1      -11.9      -25.109
      4   Hong Kong       16.431          8.7      20.276       15.665         16       UK                 -55.943      -2.4      -48.332    -57.963
      5   Netherlands     50.091          7.6      39.986       55.997         17       South Africa       -14.002      -5.5      -10.118    -12.889
      6   China           184.172         7.2      160.818      206.478        18       Australia          -41.397      -5.6      -42.247    -42.325
      7   Sweden          21.895          5.8      21.57        22.846         19       U.S.               -869.129     -6.6      -791.504   -959.109
      8   Taiwan          20.68           5.8      16.116       22.04          20       Spain              -100.577     -8.3      -83.001    -115.08
      9   Germany         120.579         4.2      114.896      120.688       Totals in billions of U.S. dollars
     10   Japan           167.273         3.7      165.69       162.871
                                                                              *Account balance in percent of GDP +Estimate
     11   Canada          25.48           2.0      26.261       25.422
                                                                              Source: International Monetary Fund, World Economic Outlook
     12   Brazil          5.808           0.6      14.193       4.43
                                                                              Database, September 2006

44                                                                                                                    March 2007 • CURRENCY TRADER
                                      NON-U.S. DOLLAR FOREX CROSS RATES
            Currency                                      1-month     3-month      6-month     52-week     52-week
   Rank        pair             Symbol        Feb. 23     gain/loss   gain/loss    gain/loss     high         low       Previous
     1    Real / Pound         BRL/GBP         0.2471       3.78%       1.65%       -0.56%      0.2713      0.2274         11
     2   Real / Aussie $       BRL/AUD          0.611       2.59%       1.95%       -0.88%      0.6573      0.5633          5
     3      Real / Yen         BRL/JPY        58.4789       2.41%       7.58%        7.06%     58.4789     47.8241          1
     4  Canada $ / Pound       CAD/GBP         0.4411       2.27%      -3.88%       -6.80%      0.5041      0.4271         19
     5    Franc / Pound        CHF/GBP          0.413       1.85%      -2.75%       -4.04%      0.4452      0.4038         20
     6   Real / Canada $       BRL/CAD         0.5605       1.50%       5.79%        6.70%      0.5688      0.4746          4
     7     Real / Euro         BRL/EUR         0.3678       1.38%       2.25%        0.55%      0.3966      0.3331          3
     8  Aussie $ / Pound       AUD/GBP         0.4046       1.18%      -0.27%        0.32%      0.4266      0.3932         18
     9      Euro / Yen         EUR/JPY        158.981       0.99%       5.17%        6.44%     159.551     137.145         10
    10   Canada $ / Yen        CAD/JPY        104.369       0.88%       2.06%        0.32%     106.155     98.8723          9
    11     Franc / Yen         CHF/JPY        97.7249       0.45%       2.86%        3.29%       98.15       87.67         15
    12   Canada $ / Euro       CAD/EUR        0.6565       -0.11%      -3.31%       -5.76%       0.739       0.647         14
    13    Aussie $ / Yen       AUD/JPY        95.7224      -0.20%       5.53%        8.00%       96.43       82.09          8
    14  Franc / Canada $       CHF/CAD        0.9368       -0.43%      1.18%        2.97%       0.9609      0.8646         17
    15     Franc / Euro        CHF/EUR         0.6148      -0.52%      -2.18%       -2.94%      0.6471      0.6138         16
    16   Aussie $ / Franc      AUD/CHF         0.9797      -0.67%       2.55%        4.55%      0.9871      0.9023          7
    17 Aussie $ / Canada $     AUD/CAD        0.9176       -1.08%      3.77%        7.66%       0.9342      0.8178         13
    18   Aussie $ / Euro       AUD/EUR        0.6022       -1.17%      0.32%        1.45%        0.626      0.5761         12
    19     Pound / Yen         GBP/JPY        236.648      -1.36%      5.80%        7.65%       241.48     201.645          2
    20    Pound / Euro         GBP/EUR         1.4886      -2.34%       0.59%        1.12%      1.5296      1.4243          6
                                                     GLOBAL STOCK INDICES
                                                         1-month      3-month      6-month      52-week      52-week
  Rank Country           Index                Feb. 23    gain/loss    gain/loss    gain/loss      high          low       Previous
   1     Egypt            CMA                 2,509.36     6.01%        9.83%       25.54%      2,511.91     1,657.42        15
   2   Singapore     Straits Times           3,310.44      5.67%       16.63%       33.90%     3,310.44     2,277.91         1
   3    Australia    All ordinaries           6,007.80     5.14%       10.34%       19.01%      6,020.10     4,736.50         5
   4    Germany        Xetra Dax              6,992.58     4.70%        7.99%       21.07%      7,012.34     5,243.71         9
   5     Japan         Nikkei 225            18,188.42     4.48%       14.29%       12.53%     18,239.13    14,045.53        10
   6     Mexico           IPC                27,972.23     4.33%       13.11%       34.86%     28,678.31    16,464.62         3
   7      Brazil        Bovespa              46,015.79     4.17%        9.38%       29.56%     46,752.13    32,057.32        12
   8    Canada     S&P/TSX composite         13,343.53     3.35%        5.52%        9.42%     13,377.76    10,860.72        11
   9        UK         FTSE 100               6,401.50     2.79%        4.26%        9.24%      6,451.40     5,467.40        14
  10     France         CAC 40                5,716.38     2.53%        5.37%       12.47%      5,758.33     4,564.69         8
  11       Italy         MIBTel              32,982.00     1.95%        5.02%       15.76%     33,329.00    26,398.00         6
  12   Switzerland   Swiss Market             9,258.05     1.68%        5.79%       14.60%      9,376.65     7,123.18         4
  13      U.S.          S&P 500               1,451.19     1.62%        3.21%       12.24%      1,461.57     1,219.29        13
  14   Hong Kong      Hang Seng              20,711.65    -0.28%        7.51%       21.20%     20,971.46    15,204.86         7
  15      India         BSE 30               13,579.02    -3.29%       -0.74%       19.04%     14,723.88     8,799.01         2
                                                 GLOBAL INTEREST RATES
    Country                 Interest rate                 Rate           Last change                 Sept. 2006      Mar. 2006
    U.S.                    Fed Funds Rate                5.25           0.25 (June 06)                5.25             4.75
    Japan                   Overnight call rate           0.5            0.25 (Feb. 07)                0.25             0
    Eurozone                Refi rate                     3.5            0.25 (Dec. 06)                3                2.5
    England                 Repo rate                     5.25           0.25 (Jan. 07)                4.75             4.5
    Canada                  Overnight funding rate        4.25           0.25 (May 06)                 4.25             3.75
    Switzerland             3-month Swiss Libor           2              0.25 (Dec. 06)                1.75             1.25
    Australia               Cash rate                     6.25           0.25 (Nov. 06)                6                5.5
    New Zealand             Cash rate                     7.25           0.25 (Dec. 05)                7.25             7.25
    Brazil                  Selic rate                    13             0.25 (Jan. 07)                14.25            16.5
    Korea                   Overnight call rate           4.5            0.25 (Aug. 06)                4.5              4
    Taiwan                  Discount rate                 2.75           0.25 (Dec. 06)                2.5              2.375
    India                   Reverse repo rate             6              0.25 (July 06)                6                5.5
    South Africa            Repurchase rate               9              0.5 (Dec. 06)                 8                7

                                                      GLOBAL BOND RATES
   Rank         Country         Rate                      Feb. 23        1-month          3-month        6-month        Previous
    1           U.S.            10-year T-note            107.22         0.88%            -0.85%         0.87%              5
    2           UK              Short sterling            94.41          0.32%            -0.26%         -0.46%             3
    3           Australia       10-year bonds             94.165         0.09%            -0.30%         -0.12%             2
    4           Germany         BUND                      115.45         -0.10%           -2.14%         -1.92%             4
    5           Japan           Government Bond           134.57         -0.10%           -0.26%         1.11%              1
  All data as of Feb. 23

CURRENCY TRADER March 2007                                                                                                         45
            GLOBAL NEWS BRIEFS
            FOREX/INTERNATIONAL MARKET SUMMARY


 EUROPE                                                               G7
   France’s fourth-quarter GDP grew 0.6 percent compared to              The Group of Seven met in Essen, Germany in
the previous quarter and 2.0 percent for the year. The country’s     early February. The meeting mostly avoided dis-
December unemployment rate decreased 0.1 percent to 8.6 per-         cussing yen weakness or Japanese economic poli-
cent, a 1-percent drop from December 2005.                           cy, but instead addressed the risk of placing carry
                                                                     trades (trading the difference between two coun-
   Germany’s fourth quarter economy grew 0.8 percent from            tries’ interest rates).
Q3 and increased 3.7 percent on an annual basis. Its January
unemployment rate increased 0.6 percent from the previous
month to 10.2 percent, 1.9 percent lower than the rate in
January 2006.                                                         Interest Rates
   The UK’s jobless rate for the fourth quarter fell 5.5 percent,
                                                                           The Bank of Japan (BOJ) increased its
a 0.1-percent drop from the third quarter. The rate was 0.4-per-
                                                                           overnight call rate 0.25 percent to 0.5 per-
cent higher than the same period in 2005.
                                                                     cent in February, its second rate hike since ending
                                                                     a six-year long “zero interest rate” policy in 2006.
 ASIA & AUSTRALIA                                                    For more on the BOJ’s decision, see “Japan raises
                                                                     interest rates.”

   Australia’s January unemployment rate increased 0.1 per-
                                                                          In February, the central bank of Sweden
cent from the previous month to 4.7 percent. The rate dropped
                                                                          (Riksbank) raised its benchmark repo rate
0.7 percent from January 2006.
                                                                     25 basis points to 3.25 percent, its highest level
                                                                     since mid-2003. After adjusting rates only once (a
   Preliminary data indicates Hong Kong’s November-to-
January unemployment rate remained unchanged from the                50 basis-point drop) in 2005, the Riksbank has
previous three-month period at 4.4 percent and dropped 0.8           now upped rates seven times since the beginning
percent from a year earlier. The jobless rate is the country’s       of 2006. Along with the rate increase, the bank
lowest in six years.                                                 announced it planned to raise rates only once
                                                                     more in the next six months, surprising analysts
   Japan’s fourth-quarter GDP grew 1.2 percent on a quarter-         who expected more frequent increases.
over-quarter basis and 2.1 percent on a year-over-year basis
(based on preliminary data). The country’s January unemploy-               The Bank of Indonesia continued its tight-
ment rate fell 0.1 percent from the previous month to 4.1 per-             ening cycle, dropping its benchmark BI inter-
cent, a drop of 0.4 percent from the previous year.                  est rate 25 basis points in February to 9.25 per-
                                                                     cent. The reduction was the eighth in as many
   Singapore’s fourth quarter GDP increased a robust 7.0 per-        months and the ninth since April 2006. The BI rate
cent over the third quarter and 8.2 percent from the same quar-      has declined 3.5 percent since January 2006,
ter a year prior. The fourth-quarter jobless rate fell 0.1 percent   when it stood at 12.75 percent, although the 2004
from the previous quarter to 2.6 percent.                            closing rate was 7.4 percent, and 8.3 percent in
                                                                     2003.

 AMERICAS                                                                   Mexico’s central bank decided to hold its
                                                                     benchmark Cetes interest rate steady at 7 per-
   Brazil’s December unemployment rate dropped 1.1 per-              cent in February but said it would monitor inflation
cent as the number of unemployed people decreased by                 and not hesitate to change rates in March if infla-
291,000. The rate was 0.1-percent higher than it was in              tion is not better controlled. In a statement, the
December 2005.                                                       bank said, “If [core inflation] doesn’t [begin falling in
                                                                     March], the board will tighten monetary policy in
    Brazil’s central bank will hold an auction in March for          order to bring inflation in line with the goal.” The
purchasing U.S. dollars on the spot forex market in an effort to     bank typically targets inflation at 3 percent annual-
increase the country’s international reserves. Currently, Brazil     ly, but February figures indicate inflation for the
has about $100 billion in foreign reserves, more than the coun-      trailing 12-month period was 4.06 percent.
try has ever had.


46                                                                                          March 2007 • CURRENCY TRADER
              FOREX RESOURCES
                                                                                           BOOKSHELF
NEW PRODUCTS AND SERVICES
    FXCM has introduced a new currency hedging product enabling its trader-
clients to hedge a current position by placing opposing orders — that is, taking
long and short positions in the same currency pair at the same time. The prod-
uct is available to any FXCM client who elects No Dealing Desk execution. The
new hedging system allows traders to create opposing orders of the same
amount, buying and selling the same number of lots of the same currency pair
simultaneously. For more information, visit www.fxcm.com.

    TradingEducation.com has launched a new Web site, www.Trader
                                                                                           Adventures of a Currency
Chat.com, designed to provide futures, forex, and equities traders with an open
forum for sharing ideas and strategies. Discussions range from strategies, tech-           Trader: A Fable about Trading,
nical analysis tools, and software to trading techniques and current events.               Courage, and Doing the Right
Reviews and tutorials are also available on TraderChat.com. Membership is free.            Thing
                                                                                             By Rob Booker
    Ensign Software now provides free real-time forex quotes and charts                      Wiley & Sons, 2007
with all Ensign Windows charting software subscriptions. In addition, Ensign                 Hardcover, 221 pages
Windows is now compatible with FXCM and CyberTrader data sources. The                        $55
complete list of supported data sources includes eSignal, DTN IQfeed,
Interactive Brokers, FXCM, CyberTrader, and QFeed. Download a free trial use               Booker weaves a tale about fiction-
of Ensign Windows at www.ensignsoftware.com.                                               al character Harry Banes who rep-
                                                                                           resents the common investor look-
    Tradency BVI has partnered with FXDD to create FXDDAuto, an auto-                      ing to conquer the currency trading
mated currency trading platform. This allows forex traders using the                       market. Banes suffers from many
FXDDAuto platform to streamline their efforts, adjust strategies, and, under               financial and mental setbacks early
proprietary arrangements, use the platform to develop, test, and offer their own           in his career, but with the help of a
systems. FXDDAuto’s service offers a subscription-free approach to trade or sig-           mentor, he becomes a full-time
nal selection, an innovation that enables traders to design and test portfolios            trader.
using real time, historical data. Traders can combine systems and signals into
custom portfolios in real time. FXDDAuto allows traders to select strategies and
trade them automatically via remote servers. The platform records every trade
and offers traders a detailed audit trail of their activities. For more information,
visit www.fx-auto.com.

    FXYARD, the Nicosia, Cyprus-based online forex trading company, has
partnered with ActForex to provide international forex investors an online trad-
ing platform. The company will now provide its customers ActForex’s technol-
ogy and execution with FXYARD’s customer support. By providing dealing
desk access to all customers, the demands made by other brokers for large
deposits or volume limitations are eliminated. For additional information visit
www.forexyard.com.                                                                         The Forex Chartist Companion:
                                                                                           A Visual Approach to Technical
    Graphical Pattern Scanner (GPS) software from forex broker Inter-                      Analysis
bank FX (IBFX) is now being offered for free to help currency traders predict                By Michael Duane Archer
potential market trends. The main feature of IBFX-GPS is its ability to identify             and James Lauren Bickford
the various chart patterns regularly seen in forex trading. The most common                  Wiley & Sons, 2007
patterns, and those available through IBFX-GPS, are triangles, channels,                     Paperback, 361 pages
wedges, and head-and-shoulders patterns. IBFX-GPS identifies which pattern                   $85
the market is trending towards, enabling traders to make a more educated deci-
sion. IBFX-GPS is available as a free download at www.interbankfx.com. In                  The book provides graphical expla-
order to use the IBFX-GPS tool, traders must have either a live account (full              nations of forex market behavior
functionality) or a demo account (limited functionality).                                  and discusses day trading tech-
                                                                                           niques, forex swing charting, the
Note: Forex Resources is a forum for industry businesses to announce new products and      Goodman swing count system,
upgrades. Listings are adapted from press releases and are not endorsements or recommen-   reversal charts, and entry timing.
dations from the Active Trader Magazine Group. E-mail press releases to
editorial@currencytradermag.com. Publication is not guaranteed.


CURRENCY TRADER • March 2007                                                                                                   47
              GLOBAL ECONOMIC CALENDAR                                                                    MARCH/APRIL
                                                                                                              MONTH

Legend                              March                                             20   • U.S.: FOMC meeting
                                     1 • U.S.: ISM                                         • Japan: Monetary policy meeting
CPI: Consumer Price Index
                                           • Japan: Account balances                       • Great Britain: Capital issues; CPI
ECB: European Central Bank                                                                 • Germany: PPI
FOMC: Federal open market
                                           • Australia: Index of commodity prices
                                           • Canada: Balance of international              • Canada: CPI
committee
GDP: Gross domestic product
                                            payments                                  21   • U.S.: FOMC meeting
                                           • Czech Republic: CNB board meeting             • Canada: Retail trade; leading
ISM: Institute for Supply
                                                                                            indicators
Management                            2    • Japan: Monetary base
PPI: Producer Price Index                  • Canada: GDP                              22   • U.S.: Leading indicators
                                      3                                                    • ECB: Governing council and general
                                                                                            council meeting
                                      4
                                                                                      23
Economic           Release time       5    • Germany: Retail turnover
release (U.S.)              (ET)                                                      24   • Mexico: Monetary policy
GDP                     8:30 a.m.     6    • Australia: Reserve bank meeting                announcement
CPI                     8:30 a.m.          • Canada: Interest rate announcement
                                           • Brazil: Monetary policy committee        25
ECI                     8:30 a.m.
PPI                     8:30 a.m.
                                            meetings                                  26   • Hungary: Monetary Council meeting
                                      7    • Great Britain: Monetary Policy                • Israel: Announcement of interest-rate
ISM                     8:30 a.m.
                                                                                            changes
Unemployment            8:30 a.m.            Committee meeting
Personal income         8:30 a.m.          • Germany: Orders received and             27   • Japan: Corporate service price index
Durable goods           8:30 a.m.            manufacturing turnover                        • Poland: Monetary Policy Council
Retail sales            8:30 a.m.          • Australia: Official reserve assets             meeting
Trade balance           8:30 a.m.          • Brazil: Monetary policy committee             • Slovakia: Situation report on monetary
Leading indicators        10 a.m.            meetings                                       development
                                      8    • ECB: Governing council meeting           28   • U.S.: Durable goods
                                           • Great Britain: Monetary Policy                • Great Britain: Balance of payments
                                            Committee meeting                              • Poland: Monetary Policy Council
         MARCH 2007                        • Germany: Production index;                     meeting
28 29 30 31          1    2    3             bankruptcies
                                                                                      29   • U.S.: GDP
4    5    6     7    8    9 10             • New Zealand: Official cash rate               • Sweden: Executive Board monetary
                                             announcement
11 12 13 14 15 16 1 7                                                                       policy meeting
                                           • Philippines: Monetary board meeting           • Czech Republic: CNB board meeting
18 19 20 21 22 23 24
                                      9    • U.S.: Unemployment; wholesale            30   • Canada: Unemployment; GDP
25 26 27 28 29 30 31                         inventories; trade balance
                                                                                           • Australia: International reserves and
                                           • Germany: Foreign trade                         foreign currency liquidity
         APRIL 2007
                                      10                                              31   • Great Britain: Productivity
1    2    3    4     5    6    7      11
8    9    10 11 12 13 14              12   • Japan: Balance of payments;            APRIL
                                             corporate goods price index
15 16 17 18 19 20 21                                                                  1
                                           • Hungary: Monetary Council meeting
22 23 24 25 26 27 28                                                                  2 • U.S.: ISM
                                      13   • U.S.: Retail sales                            • Japan: Account balances
29 30     1    2     3    4    5
                                      14   • Japan: Monetary survey                        • Australia: Index of commodity prices
                                           • Great Britain: Unemployment              3    • Japan: Monetary base
The information on this page is       15   • U.S.: PPI                                     • Germany: Retail turnover
subject to change. Currency                • Germany: CPI                                  • Australia: Reserve bank meeting
Trader is not responsible for              • Canada: Manufacturing survey             4    • Great Britain: Monetary policy
the accuracy of calendar dates             • Switzerland: National Bank meeting             committee meeting
beyond press time.                         • Norway: Monetary policy meeting               • Germany: Orders received and
                                      16   • U.S.: CPI                                      manufacturing turnover
                                      17                                              5    • Great Britain: Monetary policy
                                                                                            committee meeting
                                      18
                                                                                           • Germany: Production index
                                      19   • Japan: Monetary policy meeting
                                           • Canada: Wholesale trade                  6    • U.S.: Unemployment; wholesale
                                                                                            inventories




48                                                                                               March 2007 • CURRENCY TRADER
             KEY CONCEPTS

Average and median: The mean (or average) of a set of               buy a high-yielding currency while simultaneously selling
values is the sum of the values divided by the number of            a low-yielding currency.
values in the set. If a set consists of 10 numbers, add them
and divide by 10 to get the mean.                                   Channel breakout: A basic trend-following technique
   A statistical weakness of the mean is that it can be dis-        that goes long on a move above the n-day high and revers-
torted by exceptionally large or small values. For example,         es and goes short on a move below the n-day low, with the
the mean of 1, 2, 3, 4, 5, 6, 7, and 200 is 28.5 (228/8). Take      expectation price will continue in that direction. For exam-
away 200, and the mean of the remaining seven numbers is            ple, a short- to intermediate-term channel breakout
4, which is much more representative of the numbers in this         approach would be to buy when price moves above the 20-
set than 28.5.                                                      day high and short when price falls below the 20-day low.
   The median can help gauge how representative a mean
really is. The median of a data set is its middle value (when       Current account: The value of a country’s total export
the set has an odd number of elements) or the mean of the           of goods and services minus its total imports of same.
middle two elements (when the set has an even number of
elements). The median is less susceptible than the mean to          LIBOR (London Interbank Offered Rate): A global
distortion from extreme, non-representative values. The             benchmark for short-term interest rates, the LIBOR repre-
median of 1, 2, 3, 4, 5, 6, 7, and 200 is 4.5 ((4+5)/2), which is   sents the interest rate at which banks can borrow funds
much more in line with the majority of numbers in the set.          (denominated in many different currencies) from other
                                                                    banks in the London money (interbank) market.
Carry trades involve buying (or lending) a currency with
a high interest rate and selling (or borrowing) a currency          Outlier: An anomalous data point or reading that is not
with a low interest rate. Traders looking to “earn carry” will      representative of the majority of a data set.




             EVENTS

Event: 31st Annual International Futures Industry                   Location: Espace Pierre Cardin, Paris
Conference
                                                                    For more information: Visit www.salonAT.com
Date: March 14-17
                                                                                                 •
Location: Boca Raton Resort & Club, Boca Raton, Fla.
                                                                    Event: The Options Course for Advisors and Planners
For more information: Visit
                                                                    Date: May 22
www.futuresindustry.org/boca2007-2735.asp
                                                                    Location: CBOE, Chicago, Ill.
                               •
                                                                    For more information: Visit www.cboe.com
Event: Wealth Expo
                                                                                                 •
For more information: Dates and locations are listed
here or visit www.thewealthexpo.com                                 Event: The Traders Expo San Diego
Date: March 16-18                                                   Date: June 20-23
Location: Atlanta, Ga.                                              Location: Marriott Hotel & Marina, San Diego, Calif.
Date: April 27-29                                                   For more information: Visit www.tradersexpo.com
Location: Anaheim, Calif.
                                                                                                 •
Date: Sept. 29-Oct. 1
Location: Seattle, Wash.                                            Event: Forex Trading Expo

Date: Nov. 30-Dec. 2                                                Date: Sept. 15-16
Location: Schaumburg, Ill.                                          Location: Mandalay Bay Hotel and Casino, Las Vegas,
                               •                                    Nev.

Event: 8th Annual Technical Analysis Expo — Paris                   For more information: Visit
                                                                    www.forextradingexpo.com
Date: March 23-24



50                                                                                              March 2007 • CURRENCY TRADER
             FOREX TRADE JOURNAL

With resistance looming, pressure
builds for run to the highs.


TRADE

Date: Monday, Feb. 26.

Entry: Long the euro/U.S. dollar (EUR/USD) pair at
1.3170.

Reason(s) for trade/setup: Following the early-
year sell-off, the euro/dollar pair moved sideways to
up for the better part of a month. After breaking out
above this trading range on Feb. 14, price again moved
sideways (although this move also had a slight upward
bias) for nearly two weeks. During this second, shorter                                                                 Source: TradeStation
consolidation, several commonly followed trend signals trig-
gered, including any number of short- to intermediate-term
channel breakout signals.                                             Initial target: 1.3270, which is 0.0025 below the January 2007
   For example, a 30-day high breakout occurred on Feb. 20,           high; take partial profits and raise stop; secondary target —
after which the market pulled back slightly, only to make anoth-      1.3360, which is just below the December 2006 high of 1.3364.
er 30-day high on Feb. 26. Testing revealed that a 30-day upside
breakout that followed a 30-day upside breakout five days ear-        RESULT
lier had a better than 60 percent chance of a higher close four
days later, with a median gain over this period of 0.0128.            Exit: Trade still open, marked to market at 1.3247 on
   We entered on Feb. 26 on an intraday pullback at 1.3170. One       Feb. 27.
potentially beneficial development on the horizon: With the
euro/dollar consolidating at this level, many short-term traders      Profit/loss: +0.0077 (0.06 percent).
are likely selling at our entry level, which they perceive as
short-term resistance. Any up move — especially above the             Trade executed according to plan? No.
round-number price of 1.3200 — could trigger short-covering
and give the market a nice, fast lift.                                Outcome: The market made such a nice up move almost
   Chartists will no doubt see the market’s recent highs around       immediately after the entry (up to 1.3194 by the close and up
1.3290 and 1.3360 as future resistance areas (see weekly chart        nearly 1.3250 the following morning), the stop was raised to
inset). As the first of these levels dovetails nicely with the gain   breakeven (1.3172, to cover trade costs) on Feb. 27. This action
indicated by the quantitative analysis, it is a good place to take    diverged from the letter of the trade plan, but as it constitutes
partial profits.                                                      reducing the position’s risk without unnecessarily limiting its
   It must be pointed out that underlying this trade is the           profit potential, it is acceptable.
assumption the long-term bull trend in the euro will remain in          To see the result of this trade, go to www.currencytrader-
force during this life of this trade. The positive bias in most of    mag.com/marchjournal.htm between March 8 and March 31.
the signals cited here are predicated on the existence of a bull-
ish bias in this market. The relative size of the gains and the       Note: Initial trade targets are typically based on things such as the his-
odds associated with them begin to diminish after five days —         torical performance of a price pattern or trading system signal.
that is, the odds continue to favor up movement, but not to the       However, because individual trades are dictated by immediate circum-
degree of days one through four.                                      stances, price targets are flexible and are often used as points at which
                                                                      to liquidate a portion of a trade to reduce exposure. As a result, initial
Initial stop: 1.3089, which is 0.0013 below the Feb. 23 low.          (pre-trade) reward-risk ratios are conjectural by nature.


  TRADE SUMMARY
 Date     Currency     Entry      Initial     Initial       IRR       MTM           Date            P/L           LOP      LOL       Trade
                                   stop       target                                                                                length

 2/26/07 EUR/USD 1.3170           1.3089      1.3270       1.23       1.3247      2/27/07 +.0077 (0.06%) .0087             -.0007 1 day

Legend: IRR — initial reward/risk ratio (initial target amount/initial stop amount); LOP — largest open profit (maximum available profit
during lifetime of trade); LOL — largest open loss (maximum potential loss during life of trade) MTM: marked to market — an open posi-
tion’s profit or loss at the current market price.


CURRENCY TRADER • March 2007                                                                                                                 51
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52                                              March 2007 • CURRENCY TRADER
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        Historical price action for 7 major currency pairs
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CURRENCY TRADER • March 2007                                   53

								
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