My Three Open Forex Positions

  • May 27, 2004
  • Dave Floyd

FX (Forex)

The recent sell-off in the Dollar took a breather
yesterday.  At one point the DXC was within a few points of re-testing the 50
day EMA (89.95), but backed off as the day wore on.  Given how range-bound and
erratic the markets have been lately, the last thing I wanted to see was another
flip-flop across a key technical area. 

As yesterday got started it seemed as though the
Durable Goods number was sure to take the Dollar lower, it missed estimates by
200 bp’s.  However, it appears as though the market is more interested the three
month average of this number since it is notoriously volatile.  On a three month
basis, the trend appears intact.

For now, our existing positions in
USD/CAD (short) and
AUD/USD (long) & EUR/USD are
in the money.  While it will be tempting to book profits on any signs of price
reversion, we must revert back to the reasons we established the trade in the
first place:

1.  Longer-term macro view was favorable

2.  Technically solid

Until either of these are breached, or if the GDP
and Jobless Claims come in far ahead of consensus, we must endure the whipsaws
if we are to take advantage of the big move. 

I thought that this quote from Robert Savage at
Goldman Sachs summed up the FX markets in recent sessions as well as the
remainder of this week:

“Forward looking indicators
are hard to find at month-end – ISM and jobs next week will soon own the
airwaves.  The terror threats for US are clear -but have been so for so long
that its losing some of the magic.  So what to do?  Seems clear that the next
two days of FX trading will be more a flow game – fixing, hedging and portfolio
readjustments, rather than real risk taking.  Unless you have a clear view –
i.e. EUR 1.24 or JPY 108 – hard to get excited, selling volatility will be the
next blood sport.”

By the time you are reading this piece this
morning, the GDP and Jobless Claims will have been released.  With the markets
as tightly coiled as they have been it will not have taken much a deviation from
consensus to send the FX markets dashing off in yet another knee-jerk reaction.

Frankly, if you did not get some trades under
your belt early in the week, it may be tough to do it as we head towards the
holiday weekend.  As mentioned above, fixing, hedging and re-adjusting will
likely be the order of the day.  Assuming the the Dollar is still under a bit of
pressure on the heels of these reports, I will maintain my three open positions
from last Friday:

Long             EUR/USD

Long             AUD/USD

Short             USD/CAD

The last
few weeks have certainly been rather indecisive as any FX trader will attest
to.  What one moment seems like a solid technical set-up, is a failed move the
next moment.  Last week I had mentioned that there were four factors weighing on
the market at present.

  1. Strong
    US jobs and inflation data have eliminated any hope that the Fed will be on
    hold until 2005

  2. China’s
    tightening raises fears of a “hard landing”

  3. Rising
    oil prices


  4. Terrorism and geo-political risks

^next^

Perhaps it
is reason #2 that is the one that is most overblown.  Let’s look at the facts. 
Since the early 80’s China has experienced some rather large swings in GDP,
which inevitably led to some boom/bust periods.  (See chart below).  As you can
see, the present level of GDP growth/contraction is far more measured. 


The collapse in China’s economy
during the early1980s and 1990s was preceded by a rapid acceleration in GDP.
During this cycle, the recovery began
five years ago, and GDP has grown marginally from 7% to 9-10% over the past
several years. Therefore, China’s economy should decelerate at a slower pace
this time around.

Secondly,
with the Federal Reserve on the verge of raising interest rates, this will slow
the influx of “hot money” into China as US assets become more attractive.  This
scenario alone will allow Chinese policy makers plenty of breathing room and not
force them to have to raise rates as a way to take some steam out of the
economy.  History clearly demonstrates that monetary policy in China vs. the US
is always opposing.  If the US is raising, China is either flat or easing. 
Without the prospect of higher US rates, the China hard-landing would in fact be
more of a possibility.

With the
likely outcome of a soft landing in China, it makes sense to start looking at
the commodity-sensitive currencies.  As you know they have been sold off heavily
in recent weeks on the prospects of a China hard-landing.  As a result, we have
decided to establish long positions in the AUD/USD and short the USD/CAD.

EUR/USD

Comments
last week by Fed Governor Ben Bernanke dealt a blow to the recent rise in the US
Dollar.  Comments that were rather dovish on the pace of rate rises and some
comments alluding to the structural problems facing the US Dollar were not what
long Dollar players wanted to see.  With the EUR/USD having held solid support
in recent weeks, long EUR/USD positions are beginning to make a lot of sense not
only from a technical perspective, but also from a macro perspective. 


With the exception of the above mentioned trades, I would still
suggest laying low on “Swing Trades” as price action is still too erratic.  The
trades discussed this week are macro and to a lesser extend technically based. 
They will need time to play out and the stop losses should be set wider than
normal. 

Enjoy the long weekend,


Dave