FXIBonline Third Quarter Report 2010

Foreign Exchange Market
In the third quarter we saw the dollar sell off across the board, due to the Federal Reserve board being  bearish on the US economy and considering more Quantitative Easing towards the end of the year if need be. We do not foresee the Fed needing to institute more QE because we believe this summer was a soft patch in the economic recovery and will strengthen going into the fourth quarter. The US dollar has recently declined to a six month low against the Euro, the stronger Euro is already negatively impacting smaller European counties such as Greece and Ireland that actually need the Euro to depreciate to remain competitive and finance their debt.  It is also interesting to note that US dollar shorts have hit a high not seen since mid-2008. In mid-2008, the EUR/USD was trading at 1.60 and eventually sold off to 1.23 as traders and asset managers reduced their dollar short positions.  A benefit of the weaker dollar  is it will help our exports creating a positive impact on our economic recovery. The weaker dollar will act as a mini “stimulus” and should help the manufacturing sector which has been leading the recovery. A recent report by Bloomberg utilizing a purchasing power basis estimated that the Australian dollar was overvalued by as much as 67%. Not only does a strong Australian Dollar have a negative impact on the Australian economy, but it means that at some point Australia will need to take steps to curb the strength of their currency to prevent deflation.

Commodities
This past quarter we saw commodities prices at record highs.  Wheat hit 815.50 a bushel and currently is trading around 700, up almost 67 percent from its low in early June of 474.  Corn hit a high of 536 from its yearly low of around 356 also established  in June. This price action was prevalent throughout the commodity sector during the third quarter, including gold and silver which are enjoying all time highs.  What is causing this?  Russia was an unfortunate recipient of poor weather this year resulting in damaged crops with the consequence being a cap on their commodities exports. Australia has also struggled with production given their weather patterns however, the U.S. has managed to remain fairly consistent because of our technological advances such as irrigation and types of seed. One exception to this quarter’s commodity rally is oil. Oil has not enjoyed this surge in pricing primarily due to the underlying economic factors surround global expansion. Not even the massive oil leak in the Gulf of Mexico was able to  push prices significantly higher.  These kind of price increases remain unsustainable in the short term given that the US still has a 9.5% unemployment rate.  Many market participants including us at FXIB compare this current situation to that of oil in the summer of 2007.  When prices of commodities rise this high this fast the shock to the global system hits in waves, these waves cause mini bubbles in prices not only for food producers and consumers but in how banks structure loans and lines of credit based on overcapitalized hard assets.   As a result of these bubbles when markets do re-align themselves, (and they will as we saw with oil) you are left with over priced bonds, loans and market valuations that will not be able to be sustained at these historical price levels.  What does this mean for the average investor?  Be careful buying commodities or commodity tied investments at these prices. Based on our research, gold is not an effective hedge against inflation, but is  rather more effective as a  hedge against the debasing of the US dollar. If the US Federal Reserve does start more Quantitative Easing, commodities could rally further however, we do not believe the Fed will need to do another round of Quantitative Easing.

Fourth Quarter Outlook
Given this backdrop, we expect commodities and commodity related investments to sell off in the fourth quarter and possibly into the first quarter of next year. We expect the US dollar to recovery some if not all of its recent losses and will keep a close eye on the US Federal Reserve statements as to any clues or direction they may take in regards to Quantitative Easing. We are also keeping an eye on the Chinese Currency Bill that just recently passed the US House of Representatives. The bill labels China as a currency manipulator and gives US companies the ability to levy charges on Chinese imports. If this bill is signed into law, we should see AUD/USD sell off as a proxy for the USD/CNY exchange rate. This bill is the toughest response by the US in regards to China’s polices.  A currency war is already raging behind the scenes in which each country is trying to devalue their currency to stimulate economic growth. (what we call a race to the bottom).  We do expect volatility to remain about the same, and we will continue to keep on eye on the leading economic indicators for the US economy.

This Week In Review: 09/12/10 – 09/17/10

EUR/USD – This week the cross closes higher then the close of last week at 1.3047.  We did have a pretty volatile week, in which we saw EUR/USD rally to a high of 1.3158.  We believe this pair will remain range bound between 1.2600 and 1.3200 over the next few trading days. A break  above or below either level should see continuation of that  move.

GBP/USD – This pair also ends higher against the dollar, it closed out last week at 1.5355 and this week it closes at 1.5629. Trading range was from 1.5347 – 1.5728. GBP/USD is still above the bullish trend line so it could see further gains, but resistance at 1.60 could cap any rallies.  We have a slightly bullish bias on GBP/USD  at this point in time.  A close below the bullish trend line at 1.5380 would probably see increase selling while a break below 1.5300 could open the door to 1.5100.

USD/JPY – This cross has been the story of the week with the Bank of Japan intervening to prop up its currency. And it is on that note that USD/JPY finishes this week extremely higher then it opened up at.  USD/JPY is the only currency cross this week to post a very strong dollar rally. As stated in our previous post, we expect USD/JPY to reach 88.00 – 90.00 before the Bank of Japan stops intervening. If short this pair, it is recommend to use a tight stop loss.

AUD/USD –  Ends this  week at .9360 and closes right at the bullish trend line support. A break below .9330 could see selling pressure increase. Aud also failed to fill the 30pip gap from last weekend, so that could act as a gravitational force for price in the coming week.  We expect the RBA to remain on alert and to sell AUD above .9400, we believe this is the primary reason as to why gains past .94 have been limited and this cross could remain a volatile pair.

NZD/USD – Tagged  along with AUD, but ends the week lower against the dollar at .7256. We  not only  had one trading opportunity on this pair, but two.  Both trades ended up closing out in profit and at this point we have a neutral outlook. It is still above the bullish trend line, but we will look to go long if it reaches .7150 (just above the bullish trend line) And of course we’ll look to re-short the cross if it rallies up to .7350,  resistance at .7400 has been capping rallies so far.

USD/CAD –  This pair ends the week exactly were it opened, at 1.0331.  The cross tested the bearish trend line today and closes right at it. USD/CAD has been range bound between 1.0100 and 1.0675 over the last few weeks. We expect this range to continue for the next few days. We have a slightly more bullish outlook on this cross and will look to go long once we get a confirmation that the downtrend has broken.

USD/CHF – This is a pair we have been watching for awhile now, just when you think a bottom is in place, it sells off. Despite the probe lower to .9928, this cross manages to close above parity at 1.0096.  It does close lower then it opened at,  reversing all of last weeks gains. 1.0275 is resistance on the way up, and  the cross will now need to  close above 1.0280 for us to consider a bottom has been put in place.   Traders are still heavily short CHF crosses and we  think that it is highly susceptible to a short covering rally. One interesting note is that the Bank of Japan intervention in USD/JPY helped propel USD/CHF back above parity, whether that can be attributed to traders  unwinding short positions on concerns about a possible SNB intervention or just BoJ buying up a lot of dollars is hard to say.

Hope everyone had a good week!

Bank of Japan Intervenes in Forex Market

09/15/10 - Click to Enlarge

Early yesterday evening during the Asian session the Bank of Japan intervened in the Forex Market to prop up its currency.  The USD/JPY promptly rallied from 82.85 to 83.75 in about 15 mins. The Bank of Japan continued to intervene in the market during the European Session,  with the JPY weakening across the board against the major currencies.  The Bank of Japan has stated that they will continue to intervene in the market to prop up its currency. It is estimated that the Bank of Japan has already bought up  $230 billion in US Dollars.  The Japanese do have a huge war chest to intervene in the Forex Market, their foreign reserves are totaled to be a little over $1 trillion dollars.  Unlike the SNB (Swiss National Bank), the Bank of Japan has a history of success in propping up its currency, so this intervention is not to be taken lightly. The last time the Bank of Japan intervened was in 2004, and they weakened the Yen from 104 to 114.  At this time, we are speculating that USD/JPY could reach 88.00 or 90.000 before the Bank of Japan stops intervening.

NZD/USD Trade Update:

We still have our short postion on NZD/USD open at this time. We are keeping our profit target at .7270 and our stop loss at .7410.