Strategies, analysis, and news for FX traders
Volume 6, No. 6
PATTERN + FILTER: Screening intraday FX trades p. 20
HOW RISK AVERSION DRIVES
the FX market p. 14
CAN CHINA LEAD THE GLOBE
out of recession? p. 8
and the forex market p. 10
and Treasury returns p. 26
chafe at new NFA
rule p. 36
Midpoint filter for intraday FX . . . . . . . . .20
What happens when you use the previous
day’s range to determine when to take long
Contributors . . . . . . . . . . . . . . . . . . . . . . . . . . .6 or short trades the next day?
By Currency Trader Staff
All eyes on China . . . . . . . . . . . . . . . . . . . . .8 Advanced Strategies
China’s recent economic numbers have been Currency volatility and long-term
encouraging, but questions remain about their treasury returns . . . . . . . . . . . . . . . . . . . .26
validity and whether the Asian dragon can light The belief that higher currency volatility leads to
the world economy on fire by itself. steeper yield curves and negative bond returns
By Currency Trader Staff has been challenged by the 2008-2009 financial
For now, protectionist By Howard L. Simons
banter recedes . . . . . . . . . . . . . . . . . . . . .10
continued on p. 4
So far, we’ve avoided a global trade war
driven by protectionism. Another economic
downswing could put nations to the test,
By Currency Trader Staff
On the Money
Risk aversion . . . . . . . . . . . . . . . . . . . . .14
Extraordinary times call for out-of-the-box
thinking about markets.
By Barbara Rockefeller
2 June 2009 • CURRENCY TRADER
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FIFO mandate causes headaches
for U.S. FX dealers . . . . . . . . . . . . . . . . . .36
The NFA’s new rule regarding first-in-first-out
trade exits has forex dealers rushing to make
the necessary changes to their platforms.
By Chris Peters
International Markets . . . . . . . . . . . . . .38
Numbers from the global forex, stock,
and interest-rate markets.
Global Economic Calendar . . . . . . . . . . . .41 Events . . . . . . . . . . . . . . . . . . . . . . . . . . . . .42
Important dates for currency traders. Conferences, seminars, and other events.
Key concepts . . . . . . . . . . . . . . . . . . . . . . .42 New products & services . . . . . . . . . . . . . .43
Have a question about something you’ve seen in
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4 June 2009 • CURRENCY TRADER
All eyes on China
The question now isn’t whether or not the world will catch cold if China sneezes — it’s whether or not
the world will regain its appetite if China puts away its Kleenex and aspirin.
BY CURRENCY TRADER STAFF
ecent economic reports out of China have sur- first coming out, but may not have the strength to lead the
prised on the upside, leading some market world out.”
watchers to cast their gaze eastward in the Stephen Webster, director of London-based TopEcon,
search for the growth engine that will propel frames it differently. “I believe it is more accurate to say
the global economy out of its current recession. that China [will] outperform most other economies in the
The International Monetary Fund (IMF) is projecting a next two years and make a significant contribution to glob-
1.3-percent decline in global growth in 2009 — the first con- al recovery, alongside other key countries like India.”
traction since World War II, and well below the 4- to 4.5- As evidence, Webster cites IMF forecasts for China to
percent average global gross domestic product (GDP) post 6.5-percent GDP growth in 2009 and India to come in
growth rate of the past 20 years. While the U.S. remains at 4.5 percent, vs. -2.8 percent in the U.S. and -4.2 percent in
mired in negative growth numbers, with GDP plunging 5.7 the Eurozone. Webster notes the IMF expects China and
percent in Q1 2009, China might have already hit its eco- India to grow at 7.5 and 5.6 percent rates, respectively, com-
nomic low point and be climbing higher out of its econom- pared to a zero GDP reading for the U.S. and a -0.4 percent
ic morass. GDP rate in the Eurozone.
The question is, can it power the rest of the world to Although the Chinese growth engine will play a pivotal
recovery? role, it is itself part of a larger system.
“China’s rebound should also have an important positive
impact on global confidence and on commodity prices,”
The Chinese economy will play Webster adds. However, he warns this process will take
time. “In part, it’s a vicious circle, with China’s revival
a pivotal role in a global recovery, depending on demand from the U.S. and Europe.”
but it is itself simply a part of Recent numbers: Low, but stabilizing
When assessing China’s economic strength and the
a larger system. progress of its recovery from the global economic crisis,
“what you see from China is not always what you get,”
says James Pressler, associate international economist at the
Can the Dragon lead? Northern Trust Company in Chicago.
Not alone, according to Sherman Chan, economist at For example, Pressler notes that China issued its first-
Moody’s Economy.com. Despite its burgeoning clout, quarter 2009 GDP data ahead of the U.S. and that China
China does not yet outweigh the U.S. and other economies does not revise its GDP figures. “The exact figures are sub-
that are still floundering. ject to a degree of politicization, but what’s more important
“Although China’s economy maintains a positive out- is the trajectory of slowing growth,” he says.
look, the dragon is not powerful enough to end the global Released in mid-April, Q1 Chinese GDP came in at 6.1
recession,” he says. “Despite years of stellar GDP growth, percent year-over-year. That sounds stellar from an
China still ranks behind the U.S. — the epicenter of the American perspective, but as Pressler points out, that num-
global turmoil — in contribution to world output. The com- ber is “the lowest rate of growth they have posted this
bined influence of the major economies in recession — the decade.” (Q2 2008 GDP was 10.1 percent, Q3 2008 was 9
U.S. along with Europe and Japan — is far too great for percent, and Q4 2008 was 6.8 percent.)
China to offset. The most China can help in this global cri- But that, Pressler adds, might be good news in the longer
sis is to cushion the downturn in some economies through run.
imports.” “At this point, we feel that growth has reached its low
Mingchun Sun, chief China economist at Nomura point. We feel the second quarter GDP figure will be better
International, agrees. “China is still a relatively small por- than the first quarter,” he says.
tion of the world economy,” Sun says. “China will be the In the wake of stronger-than-expected economic news,
8 June 2009 • CURRENCY TRADER
Moody’s Economy.com recently upped its 2009 China GDP larger than most people expect,” Sun says.
forecast from 7 to 7.5 percent. Some analysts say China’s Webster also credits China for easing credit conditions by
huge fiscal stimulus package has helped propel a Chinese reducing interest rates and putting pressure on banks to be
recovery. more liberal in their lending practices.
Of industrial production, Chan notes that it “not only However, while the Chinese government may have
avoided falling into negative territory, but its recovery earned a pat on the back in one sense, the argument can be
came earlier than expected.” made that some of the steps they’ve taken might look better
In inflation-adjusted terms, Chinese industrial produc- in the short term than the long term. For example, Pressler
tion was 7.3 percent in April. The low point during the continued on p. 10
recent slowdown was a 5.4-percent
reading in November 2008.
“They are used to double-digit
growth,” Pressler says. Nonetheless,
the rebound in industrial production
data “shows that we are seeing fiscal
stimulus kicking in, or at least the fig-
ures suggest it is working.”
Pressler says a pickup in the export
sector is an important reason for opti-
mism. Overall, he believes the worst of
China’s export decline is over. After a
July 2008 peak of $128.7 billion,
monthly exports slowed to a low of
$68.2 billion in February 2009.
However, Pressler explains that low
reading was somewhat impacted by
the Lunar New Year that month, a
time when “production slows down
and there isn’t as much trading with
From there, the numbers have
increased. March 2009 exports were
$95.5 billion, and the April number
came in at 91.6 billion, which “puts
China back at levels seen in the first
and second quarter of 2007,” Pressler
What did they do right?
Many economists say the Chinese gov-
ernment deserves kudos for an effec-
tive stimulus package, which Pressler
says totaled around $549 billion.
“China is putting some of that
money — all those reserves it is sitting
on — into play,” says Pressler.
Webster says the fiscal stimulus was
aimed at “infrastructure, farming, and
construction projects, with some addi-
tional allocations to the social security,
welfare, and health systems.”
The measures were timely and
forceful, according to Sun. “The posi-
tive impact on consumption will prove
CURRENCY TRADER • June 2009 9
FIGURE 1 — YUAN-DER WHEN IT WILL MOVE AGAIN?
The Chinese yuan’s (renminbi) steady appreciation vs. the U.S. dollar stopped
abruptly in mid-2008; the pair has been in a tight trading range since.
notes “they are shoring [exports]
up through subsidies and loan-
forgiveness programs — shoring
them up during a time when
slower growth should weed out
the less-efficient companies.”
What are the potential repercus-
sions for this special treatment of
the Chinese export sector? “They
will continue to have an economi-
cally inefficient export sector that
will rely on an artificially weak
currency and government subsi-
dies, rather than production
FIGURE 2 — THE SINGAPORE SUBSTITUTION
enhancements, innovations, and a
rise up the value-added scale,” The Singapore dollar (SGD) has already rallied strongly off its February bottom and
Pressler explains. is closing in on its late-2008 highs. If Asia, and China particularly, continue to
rebound, the SGD could experience continued appreciation vs. the U.S. dollar,
according to economist James Pressler.
Yuan stalls out
Meanwhile, the Chinese yuan’s
steady appreciation over the past
few years has stalled (Figure 1).
“The yuan actually fell 0.16 per-
cent against the U.S. dollar in the
first quarter — the first quarterly
drop since July 2005,” Webster
By contrast, the yuan gained 2.5
percent vs. the dollar in 2005, 3.3
percent in 2006, 6.4 percent in
2007, and 6.5 percent (after being Source: http://www.advfn.com
up as much as 9.6 percent) in 2008.
“They had taken their foot off the
gas and offered a little benefit to exporters who were show-
ing signs of weakness,” Pressler says.
At year-end 2008, the yuan was trading at 6.82 vs. the
dollar and was virtually unchanged as of June 1, 2009.
“Since they unofficially manage their currency, this is
representative of them holding their currency to a level that
will support their exporters vs. U.S. interests, which call for banter recedes
a 6 or 5.9 [rate],” Pressler says.
What lies ahead? The U.S. stands to lose the most
“With recovery in China still in its very early stages, there
is no incentive to engineer an appreciation,” Webster
if protectionism sweeps the globe.
argues. “On the other hand, any depreciation would risk a
protectionist backlash.” BY CURRENCY TRADER STAFF
For those looking for an “Asian recovery play” in the
weeks or months ahead, Pressler advises looking at the
Singapore dollar (SGD, Figure 2), as the yuan is not a freely alk of protectionism usually brings to mind the
traded currency. Smoot-Hawley Tariff of 1930, which many
“If China is going to recover, it’s going to be through blame for putting the “Great” in the Great
trade,” he says. “Look at Singapore — they are known for Depression. But in recent months, little wildfires
having a great financial sector. If we witness a stronger of protectionist banter broke out in various places around
growth situation and if trade volumes rise, we should see a the globe as shell-shocked nations initially faced the
recovery in Singapore’s economy, which will have a sup- prospect of rebounding from the financial calamities of
portive affect on the Singapore dollar.” 2008. For now, however, these fires have been doused out —
10 June 2009 • CURRENCY TRADER
thanks to some economic stabilization — but economists
warn the issue of protectionism is not likely to disappear
“Protectionism results in global trade
entirely any time soon.
“Protectionist measures are clearly one of the major risks
wars nobody can afford to wage.”
to global recovery,” says Stephen Webster, director of after he encouraged automaker Renault to shift production
London-based TopEcon. “It is a big temptation for countries back into France. However, Sarkozy backed off.
to resort to infringing either the rules or the spirit of free “There has also been a lot of protectionism banter in Asia
trade to help encourage growth in their own economies.” between China and its neighboring countries,” Webster
In one of the most notable protectionist salvos in the U.S., says.
in February the $900 billion stimulus bill was initially laden continued on p. 12
with a “Buy American” clause that
stipulated that only U.S.-made goods
could be used in projects funded by
the bill. According to Jay Bryson, glob-
al economist at Wachovia, cooler
heads ultimately prevailed and the
final version was “watered down” to
state that actions had to be consistent
with current U.S. trade law.
“In the West, the U.S. seems to be
coming under the most fire for protec-
tionist tendencies,” Webster says. “For
example, Canadian Industry Minister
Tony Clement has criticized U.S.
Congress for its injurious ‘Buy
American’ rules that bar Canadian
firms from bidding on U.S. stimulus
projects. Indeed, the Buy American
provision in the U.S. stimulus bill has
resulted in opposition not only across
the globe but also from within
America itself, with the big fear that it
will lead to similar restrictions in
“Similarly, U.S. President Barack
Obama’s promise to modify tax laws
that currently allow U.S. companies to
pay less tax if they outsource to, or
create a job in, India — rather than the
U.S. — has been criticized by some
Indian factions as a protectionist
Ultimately, some argue, the issue
boils down to jobs.
“The flashpoint domestically is,
where are all the jobs? We keep send-
ing them abroad,” says Ken Goldstein,
economist at the Conference Board in
New York. “There is fancy talk about
quotas, tariffs, protectionism, and
immigration — but what it really
comes down to is jobs.”
This issue has not been confined to
the U.S. in recent months. In March,
for example, French President Nicolas
Sarkozy found himself embroiled in
the middle of a protectionist debate
CURRENCY TRADER • June 2009 11
The protectionism domino effect Free trade
Once protectionism starts, it’s very difficult to stop — a Webster puts forth the economic case for free trade. “Fair
problem everyone seems to understand economically, but competition resulting from free trade helps increase effi-
not necessarily politically. ciency and depress world prices by allowing countries to
“We are fully cognizant if we go down that path and try specialize in producing or supplying what they are good at,
to put up a wall around us, everyone will put up a wall and letting other countries specialize in the areas they are
against us,” Goldstein says. “It is less than a zero-sum best at,” he says. “Protection arguably leads to the opposite.
game.” “If emerging markets are allowed to do what they do best
Economists generally agree the Smoot-Hawley tariff is a by utilizing comparative advantage, it also helps to allevi-
clear example of the perils of protectionism. ate global poverty and reduces the need for global aid from
“It was damaging not only to the U.S. economy but also the richer countries,” he continues. “The fight against pro-
to others economies,” Webster says. “It raised U.S. tariffs on tectionism should promote the idea that everyone can
some 20,000 imported goods to record levels and many become better off and people should not be fearful of unem-
countries retaliated with by raising their own tariffs on U.S. ployment and change. Trying to protect employment by
goods. U.S. exports and imports were reduced by more raising tariffs or some other protectionist measure has a dis-
than 50 percent. Some observers blamed the tariff for caus- torting influence, and the U.S. — perhaps more than any
ing the Great Depression. That remains a controversy to other country in the world — has its industrial roots in ini-
this day, but it undoubtedly soured trading relations with tiative and entrepreneurship. In any case, protecting
other countries and caused the shrinkage of world trade.” domestic industries against foreign competition is ultimate-
Bryson agrees. Smoot-Hawley is the “poster child for ly counterproductive, since more often than not it leads to
why you don’t want to be doing this. It starts a global trade retaliation, higher costs, and lower levels of world trade.”
war that nobody can afford to wage.” For now, though, rebounding equity markets and stabi-
Bryson notes that any potential negative repercussions lizing economic statistics have put out the protectionist
from protectionist moves are merely theoretical at this flames that were burning so hot earlier in the year. If this
point. But if governments become excessively nervous turns out to be more of a respite than a reversal, however,
again and enact protectionist measures later this year or the embers may regain strength.
next, Bryson speculates that “some sort of trade war would “So far, we have not seen a lot of signs of protectionism,
affect stock markets. Global growth would probably be but if the global recession drags on, it could very well rear
slower and that would first affect companies that do a lot of its ugly head again,” Bryson says. “I don’t think this issue
international business. My guess is it would be negative for has gone away yet, but for now we have avoided the worst
the dollar.” of it. We’ll see.”
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12 June 2009 • CURRENCY TRADER
ON THE MONEY
Risk appetite and aversion explain a great deal, but not everything in the forex market.
FIGURE 1 — DOLLAR AND VIX
The dollar and the VIX moved together until January 2009, at which point the VIX
continued to decline while the DXY pushed higher into March.
BY BARBARA ROCKEFELLER
T he forex market is driv-
en by risk aversion, but
to measure risk aver-
sion, it’s necessary to
look at factors outside the FX mar-
ket, such as stock indices and the
equity market volatility index (VIX).
However, as warned in “Rational
fear and the forex market” (Currency
Trader, March 2009), you must be
wary of flaky and unreliable inter-
market correlations. You should
never trade a currency pair based on
something going in another market.
Source: data — eSignal and Reuters Online; chart — eSignal For example, you shouldn’t buy the
Euro/dollar pair because oil is going
FIGURE 2 — DOLLAR AND DOW up or sell gold because the dollar is
The dollar index and the Dow Jones Industrial Average (DJIA) appear to be better going down. This is called “sticking
correlated than the dollar index and the VIX. to your knitting” — trading the mar-
ket in front of you, not some dimly
Having warned against putting
too much faith in watching other
markets, conditions are nonetheless
extraordinary today. Just about
everyone in every market is making
decisions based on risk aversion or
risk appetite, and talking about them
in those terms.
Risk and the dollar
First, let’s define “risk aversion.”
The risk in question is the risk of loss
of capital due to expropriation,
bankruptcy, or inflation. A 100-per-
cent loss results from expropriation
— the sovereign simply takes away
your entire capital stake. Bankruptcy
Source: data — eSignal and Reuters Online; chart — MetaStock
is less damaging; usually the creditor
gets something, even if it’s only a
14 June 2009 • CURRENCY TRADER
FIGURE 3 — S&P AND EURO
As the S&P has rallied, so has the Euro — meaning, the U.S. dollar has declined.
few cents on the dollar. Inflation is
an insidious form of expropria-
tion. By creating or allowing infla-
tion, the government devalues the
purchasing power of the money,
sometimes to an extreme degree.
At the height of the global
financial-sector crisis, the dollar
was a safe haven from the poten-
tial bankruptcy of banks in other
parts of the world. Investors
believed it was safe to place cash
in U.S. bank deposits because U.S.
banks were too big to fail and/or
FDIC insurance would be effec-
tive. Because the U.S. operates
under the rule of law and had
undergone a banking crisis in liv- Source: data — eSignal and Reuters Online; chart — MetaStock
ing memory (the savings and loan
crisis of the 1980s), during which equities; now it’s the dollar on the Dow? Well, yes, but only in part.
no depositor lost money, using U.S. basis of inflation fear. It was a remark- Foreigners account for only a small
dollar bank deposits as a safe haven ably speedy transfer of risk aversion fraction of total U.S. stock-market
was a logical course of action. from one target to another. investment; domestic players such as
As risk aversion had investors in its Figure 1 shows the dramatic rise in pension funds and mutual funds are
grip, two other things happened: the the CBOE Volatility Index (VIX) in responsible for a much bigger percent-
stock markets of developed countries autumn 2008, with a rise by the dollar continued on p. 16
fell dramatically — as much as 30 to 45 index (DXY) at the same time. The two
percent — and central banks slashed indicators moved in sync until January
the return on money. The truly risk 2009, at which point the VIX continued
averse were pretty much stuck with to trail off while the dollar index
bank deposits as the only sane place to pushed higher into March and subse-
park their capital. quently trailed off by less. The VIX has
As part of the financial rescue plan, fallen in a rough line downward while
however, the Fed printed vast the dollar index has formed an upside-
amounts of new money. So far the down V.
increase in money supply is trapped in The dollar index and the Dow Jones
the banking system as “capital” and Industrial Average (DJIA) appear to
has not leaked out to the general econ- offer a better correlation (Figure 2). It
omy. But those who fear inflation are seems, though, that when the dollar
concerned that when the banks do index rose more than the Dow in
their job of recycling this money sup- March and May, the Dow’s failure to
ply through lending, inflation will follow dragged the dollar index back
inevitably follow. As economist Milton down.
Friedman said, “Inflation is always But does this make sense? On an
and everywhere a monetary phenome- outright capital-flow basis, foreigners
non.” Fed Chairman Ben Bernanke have gone from net divestiture of U.S.
might be a smart guy and have only equities last year to net buyers. The
the best intentions, but doubt runs Treasury International Capital System
high he can put the genie back in the report in May showed foreigners were
bottle. net buyers of $15.1 billion of U.S. equi-
As a result, the target of risk aver- ties in March, up from a mere $1 bil-
sion has changed. As the financial cri- lion in January (they bought $33.5 bil-
sis came to a boil in September- lion in March 2008). Does this account
November 2008, the initial target was for the rise in both the dollar and the
CURRENCY TRADER • June 2009 15
ON THE MONEY
FIGURE 4 — EMERGING MARKETS
haven) is reduced. Given this world-
The Brazilian and Indian stock markets reversed earlier than the U.S. market, and
view, a rising stock market is, per-
they have gained more off their bottoms than U.S. and European indices.
versely, bad for the dollar. Figure 3,
which shows the S&P 500 index and
the Euro/dollar pair (EUR/USD),
bears out this thesis: As the S&P
rises, the Euro rises, too.
How can both things be true —
that U.S. stocks go up on foreign
purchases but also go down on a
reduction of risk aversion? The
answer is that the “foreigners buy-
ing” story is weak and the risk-aver-
sion thesis is more powerful.
The biggest outcome from the rise in
risk aversion is the emerging bubble
in emerging-market currencies and
stock indices. Figure 4, which shows
Source: data — eSignal and Reuters Online; chart — eSignal
the Brazilian Bovespa stock index
(BVSP) and the Indian Sensex stock
FIGURE 5 — COMMODITIES index (BSESN), shows these markets
actually reversed earlier than the
China has continued to stockpile commodities, including copper and gold, U.S. market. Both indices were
contributing to robust prices unjustified by developed countries’ fundamentals. already rising in January, and after a
setback in March, they have gained
more off their bottoms than U.S. and
European indices as of June 1.
The rise in emerging-market
stocks reflects a thread in the current
thinking that emerging markets may
manage a v-shaped recovery (down,
then right back up) rather than the
L-shaped recovery (down, then side-
ways for a long time) the West and
Japan will almost certainly get. For
one thing, China implemented its
stimulus package immediately,
whereas the U.S. has hardly started.
Also, trade between China and
Brazil has gone up, not down —
unlike the trade pattern elsewhere,
with exports from Germany, for
example, down 9.7 percent in the
Source: data — eSignal and Reuters Online; chart — MetaStock first quarter this year. China has also
continued to buy and stockpile com-
age. Also, official data is released very late, so unless a mar- modities, including oil, copper, and gold, contributing to
ket participant hears a story from a broker that foreigners robust prices that are hardly justified by developed coun-
are buying again, foreign participation would tend to have tries’ fundamentals (Figure 5).
only a small effect on the Dow. The conventional wisdom is that the minute the price of
In fact, in terms of the risk-aversion paradigm, the new oil goes up, the dollar goes down. This inverse relationship
conventional wisdom argues the opposite: a rise in U.S. is another example of market perversity, since you’d think
equities means a drop in risk aversion, which in turn means demand for dollars would go up as the price of a commod-
the need for dollars parked in checking accounts (as a safe- ity denominated in dollars goes up. A rise in the price of oil
16 June 2009 • CURRENCY TRADER
FIGURE 6 — GOLD AND EURO
The differing paths of gold and the Euro currency futures suggest there are
fundamentals and market sentiment factors at work, not just risk aversion.
is also commonly interpreted as a
sign of fresh U.S. demand for ener-
gy, which means growth prospects
are looking up for the U.S.
Shouldn’t this be dollar-favor-
able, too? Not in the new upside-
down world of risk aversion.
Traders are so convinced of the
inverse relationships that a knee-
jerk sell-off in dollars occurs when
the price of oil rises; sometimes
you can see the relationship hour
by hour on the charts. It’s illogical,
but it is the way the market choos-
es to think today.
Finally, we come to gold, which
has been rising, if sporadically, as
the financial crisis has evolved.
Figure 6 shows gold (GC) and Euro
currency (EC) futures. Gold has an Source: data — eSignal and Reuters Online; chart — MetaStock
unaccountably steeper slope off
the October low. If both securities Poor’s ratings agency downgraded the ness, flexibility, and aggression of the
reflect pure risk aversion from the dol- UK’s sovereign rating from “stable” to U.S.”
lar, you’d think the slope would be the “negative” in late May 2009 on the While the rating agencies probably
same or nearly the same. Besides, they basis that total public debt outstanding lack the moxie to name the U.S. as hav-
peak and withdraw at different times. was nearly 100 percent of GDP. The FX continued on p. 18
Clearly there are fundamentals and market immediately turned to the
market sentiment factors at work, question of whether the U.S. would be
other than general risk aversion. next to be downgraded, since U.S. debt
is already about $11 trillion dollars in
Economic fundamentals an economy of about $13.5 trillion, and
The one thing missing from all the rising by the minute. That doesn’t
risk-aversion talk is the fundamentals include unfunded future liabilities of
of the economies. In December and about $44 trillion for Social Security
again in March, the FX market favored and Medicare. However, this potential
the first-in, first-out (FIFO) story that downgrade story had a short shelf life
suggested the U.S. would recover from when the Chinese quickly remarked
recession faster and more widely than publicly about their preference for the
any other country: Growth counts. dollar as the reserve currency, for spe-
Over long time periods, currencies are cific reasons. They say the dollar is still
highly correlated with inflation-adjust- the best option to meet the criteria of
ed real growth. The so-called green “safety, liquidity, and profitability,” in
shoots of recovery some analysts claim that order.
to see poking their heads out of the An official from the State
dirt are more likely to grow roots in the Administration of Foreign Exchange
liberal soil of the U.S. than in the strict- said “According to exchange-rate
ly regulated economies of Europe and trends, the Euro, sterling, and yen are
Japan. Besides, the U.S. is a vast coun- all high-risk currencies, where the dol-
try. It has, literally, room for shoots to lar has been relatively safe.” Officials
appear in many places, and while say China’s dollar holdings, almost $2
some of them will no doubt be weeds, trillion, are simply too big to hedge
the universal expectation is that the “without spooking the currency mar-
U.S. will lead the global recovery. kets.” Moreover, the Chinese like dol-
But growth is taking a back seat lar liquidity — its historic role since
today on the emergence of yet another 1945. China perceives that Eurozone
high-risk situation. The Standard & policy-making lacks “the responsive-
CURRENCY TRADER • June 2009 17
ON THE MONEY
FIGURE 7 — EURO PROJECTION
ing a “negative” outlook on the debt The standard error channel implies the Euro will be somewhere between 1.6533
to 1.2761 at year-end.
situation, the Chinese can always
change their minds — or get agree-
ment at some point that the IMF’s spe-
cial drawing right (SDR) should be the
new reserve currency (see “Treasury
backs down from China currency
manipulation stance,” Currency Trader,
May 2009). The over-indebtedness of
the U.S. is an old risk being newly
named as a special risk to the dollar.
This violates — in spades — the over-
all risk-aversion thesis that a rise in
risk aversion means a flight to the dol-
How will the current chapter end? One
likely scenario has it that a crisis will
develop in an emerging market, simi-
lar to 1997-1998, and soaring stock
markets will again tumble like domi- Source: data — eSignal and Reuters Online; chart — MetaStock
nos. It seems clear that some stock
markets are in bubble mode, so it might not take much of a beginning of the Euro) indicates that at year-end 2009, we
crisis to get a major pullback from emerging markets, to the can expect a range of 1.6533 to 1.2761, with the linear regres-
benefit of the dollar. sion line itself landing at 1.4647. The red lines start with a
Another idea floating around is that the U.S. should issue support line connecting Euro lows and spaced out to show
bonds in Euros or yen, which doesn’t reduce the total resistance and a midline.
indebtedness but might make it more attractive to some for- As a practical matter, now that the market is picking on
eign investors. Nobody is expecting realistic plans for actu- the dollar, these are probably realistic ranges, and a stronger
ally reducing U.S. indebtedness any time soon. dollar is just wishful thinking.
In Figure 7, the standard error channel (drawn to one
error on either side of the linear regression from the very For information on the author see p. 6.
Related reading: Other Barbara Rockefeller articles
“Forecasting follies,” Currency Trader, May 2009. false assumptions about how the U.S. and Europe are handling
The only technicals that provide tradable forecasts are the economic crisis.
patterns — but you have to be on the correct time frame
and you can’t forget about the fundamentals. “The six Ds of depression,” Currency Trader, December 2008.
The buck has gotten a bounce from the recent financial panic,
“Listening to the chart,” Currency Trader, April 2009. but the longer-term picture isn’t quite as bullish.
While everyone debates the ramifications of various policy
measures, what is the Euro/dollar chart saying? “Euro and dollar at parity?” Currency Trader, November 2008.
A few short months ago the world was contemplating Euro $2.
“Rational fear and the forex market” Now, the talk is all about Euro $1. What are the odds it will
Currency Trader, March 2009. happen?
Analysis of several intermarket relationships suggests the role of
risk aversion in the forex market is no cut-and-dried issue. “Crisis of confidence,” Currency Trader, October 2008.
As Wall Street and Washington prove themselves equally inept,
“Competitive devaluations, the EMU, and the yen” the dollar suffers.
Currency Trader, February 2009.
Currency devaluation never works in the long run — just ask “The dollar-oil connection,” Currency Trader, September 2008.
Japan — but that doesn’t mean panicky governments won’t use it As oil broke, so did the Euro/dollar pair. What can we learn from
to try to stem the flow of blood in the near term. analyzing bursting bubbles?
“The Euro: Prosperity or perdition?” You can purchase and download past articles at
Currency Trader, January 2009. http://store.activetradermag.com.
The belief the Euro sell-off has ended may be based on some
18 June 2009 • CURRENCY TRADER
Midpoint filter for intraday FX
A basic filter technique shows some potential, but it doesn’t solve all the problems.
BY CURRENCY TRADER STAFF
O ne of the perennial challenges of trading is
finding rules that will define the conditions
in which a trade setup will perform best. A
common example is the trend filter, which
defines an uptrending or downtrending market and allows
only signals in the direction of the trend to be executed.
Typically, the trend would be defined by price being
day pattern setup (using 30-minute bars) is filtered using
the midpoint of the previous day’s range: Long entries are
taken only when price is above the midpoint, while shorts
are executed only when price is below it. The idea is that the
immediately preceding price action provides the best con-
text for taking short-term trades — i.e., if price is struggling
to trade in the upper half of the previous day’s range, per-
above or below a moving average, or above or below the haps it’s best to trade from the short side, and vice versa.
price n bars ago. What inevitably happens, though — espe- The analysis was conducted on the U.S. dollar/Japanese
cially in the case of moving averages — is the trend filter yen pair (USD/JPY) from Jan. 21 to May 27, which spans a
can’t keep up with price action and many good trade sig- little more than four months — nearly 4,500 half-hour price
nals are ignored. bars. Figure 1 shows the market initially rallied into early
This strategy uses a slightly different approach. An intra- March, pulled back, rallied to a higher high in early April,
and then declined into May before
bouncing at the end of the month.
FIGURE 1 — ANALYSIS PERIOD
The analysis period spanned Jan. 21 to May 27 and included uptrending and The pattern
downtrending price action.
The pattern used to trigger entries iso-
lates bars that establish seven-bar lows
or highs, which are also a certain
amount lower or higher than the
immediately preceding low or high.
This setup was selected for its simplic-
ity, based on observation of several
intraday turning points in March and
April. No effort was made to optimize
the pattern in any way. The pattern
itself is relatively unimportant; the
object is to see whether its performance
improves or degrades with the addi-
tion of the filter.
The rules for a buy setup are:
1. The low of the current 30-minute
bar must be lower than the lows
of the previous seven 30-minute
Source: TradeStation continued on p. 22
20 June 2009 • CURRENCY TRADER
FIGURE 2 — PATTERN SIGNALS
2. The current low must be at least
Entry signals were abundant — perhaps too abundant — during the review win- 0.12 lower than the previous
dow, with more than 700 total signals occurring over the course of four months. low.
Formulas for these rules are:
1. Low0 < Lowest(Low1…7);
2. Low1-Low0 >= .12
Where the subscripts 0, 1, etc., refer
to the current bar, 1 bar ago, etc.
The rules are reversed for short
1. The high of the current
30-minute bar must be higher
than the highs of the previous
seven 30-minute bars.
2. The current high must be at least
0.12 higher than the previous
Formulas for these rules are:
FIGURE 3 — RAW SIGNAL
Long signals outperformed the market's slight upside bias during the analysis 1. High0 < Highest(High1…7);
period, while short signals were erratic but followed more often by selling than 2. High1-High0 >= .12
Figure 2 shows several of these
setup bars, both long and short.
Figure 3 shows the median close-
to-close gains or losses for 16 bars
after long and short setups, along
with the median one- to 16-bar moves
for all 30-minute bars in the analysis
period. Overall, the dollar-yen pair
had a very mild upward bias during
this period (black line). Price action
after buy signals (blue line) was
notably more bullish, while price
action after short signals (red line)
was erratic, but more bearish than the
typical price action.
The raw signals results are about
what we hoped for (in that they
22 June 2009 • CURRENCY TRADER
FIGURE 4 — ALL SIGNALS
weren’t flat-out wrong), so we pro- The filtered long signals outperformed their raw counterparts, while the filtered
short signal performance was mixed. The most notable result of the filter was a
ceeded to see if taking trades based on
68-percent reduction in trade signals.
the previous day’s midpoint might
help performance. Some filtering is
certainly necessary, based on the num-
ber of trades that were triggered:
There were 703 signals (339 long and
364 short) in the review period, and
given the typical gains are not particu-
larly large, commissions would nega-
tively impact profits disproportionally.
Filtering with the midpoint
A midpoint filter rule was applied as
1. Take long trades only if the
closing price of the current
30-minute bar is above the
midpoint of the previous day’s
range. not dramatic. The improvement was
2. Take short trades only if the most apparent in the final three bars.
closing price of the current (The relatively high winning percent-
30-minute bar is below the age for both sets of signals from bar 10
midpoint of the previous day’s to bar 16 — above 60 percent — might
range. be surprising, but it is likely a function
of the market’s upward bias during
Figure 4 shows how the filtered sig- this time.)
nals compared with the raw signals. Figure 6, however, shows the filter
The differences are not dramatic, but had no real improvement on the win-
they are evident. For both long and ning percentage of short trades. The
short signals, improvement is most filter increased the winning percent-
noticeable in the first five bars after age at half the bar intervals, decreasing
entry, after which results diverge. The the other half — although the
filtered bullish pattern slightly outper- improvement from bars 13-16 was
formed the raw signal for almost the noteworthy.
entire 16-bar follow-up period, while The most dramatic difference in
the filtered short pattern was more applying the filter was in the number
erratic, but still turned lower in the of trade signals, which decreased 68
final four bars. percent to 221 (109 long and 112 short).
Figure 5 compares the winning per-
centages of raw and filtered long sig- Sizing things up
nals. The filtered signals had higher Although the midpoint filter
winning percentages at 13 of the 16 improved the trade setup’s overall
intervals, but the improvement was continued on p. 24
CURRENCY TRADER • June 2009 23
profitability, increased the winning FIGURE 5 — LONG ENTRY WINNING PERCENTAGE
percentage of long trades, and reduced The filter improved the winning percentage of long trades, but not dramatically.
the number of trades dramatically, the
benefits were very modest. However,
given the large number of trade exam-
ples, there is an indication the basic
trading approach has some promise.
There are a few additional ideas to test,
and ways results might be enhanced:
1. Find a better-performing setup
pattern. The fact the rules were
simply inverted for the long and
short sides of the market leaves
room for immediate
Also, the results were based on
entering on the close of the
signal bar and exiting on the
close one to 16 bars later. These
rules provided robust results but
are likely to provide fertile
FIGURE 6 — SHORT ENTRY WINNING PERCENTAGE
ground for designing better-
performing techniques, not to The filter had a less-positive effect on the short-trade winning percentage, with
mention the use of a stop-loss. the exception of the final bars.
2. Both the time frame and filter
reference point (the previous
day’s midpoint) were
representative. In addition to
researching other time frames
(e.g., trading daily signals using
a weekly or monthly filter), other
ideas include adjusting the filter
level higher or lower based on
whether the previous day closed
up or down, or to average or
weight the midpoints of the
past n days.
The challenge is to balance the bene-
fits of filtering a signal with the
24 June 2009 • CURRENCY TRADER
and long-term treasury returns
Despite the recent currency-volatility/interest-rate disruption, the relationship should return — which
means higher long-term interest rates and lower risk multiples for stocks.
BY HOWARD L. SIMONS
FIGURE 1 — LONG-TERM RATES SELDOM EQUAL SHORT-TERM RATES
PLUS INFLATION EXPECTATIONS
Despite theory and conventional wisdom — that the long-term rate should equal the
short-term rate plus expected inflation — the 10-year Treasury note’s yield (green line)
does not add up to the sum of three-month Treasury bills (red) and the 10-year TIPS
(blue) breakeven rate of inflation. ow can we describe
this sorry decade
for financial mar-
kets? A good start
might be, “Everything you know
is wrong.” After all, lower interest
rates are supposed to be good for
equities, and yet that was dis-
proven in both directions. How
about higher commodity prices
and a weaker dollar being nega-
tive for bonds? That didn’t work
either. And the benefits of global
diversification? Um, no, that just
seemed to mean you lost money in
a large number of places simulta-
Let’s get a little more specific
and turn to one of those yield-
curve theories taught in business
FIGURE 2 — JAPANESE YEN VOLATILITY AND U.S. TREASURY YIELD CURVE:
THREE MONTHS - TEN YEARS schools and economics programs
everywhere: the “liquidity premi-
Increased yen volatility was associated with four yield curve steepenings — three
bearish (green lines) and one bullish (turquoise line). um.” Like other theories with
wide acceptance, this one makes
sense upon initial examination. It
states long-term lenders demand a
higher interest rate in compensa-
tion for expected inflation. This
should mean the long-term rate
should equal the short-term rate
plus expected inflation, with
adjustments for what are called
“preferred habitats” and “market
What do the data say? Prior to
the introduction of Treasury
continued on p. 28
26 June 2009 • CURRENCY TRADER
ADVANCED STRATEGIES FIGURE 3 — JAPANESE YEN VOLATILITY AND U.S. TREASURY YIELD CURVE
Japanese yen HLC volatility rises during a bullish steepening.
(TIPS) in January 1997, there was no
concrete, market-derived measure of
inflation expectations. The TIPS
breakeven inflation rate, which is the
difference between nominal Treasury
yields and TIPS yields at a given
maturity, is an imperfect measure (see
“TIPS, treasuries and insurance,”
Active Trader, May 2008).
Even with that caveat in mind, no
one can look at Figure 1 and match
the 10-year Treasury note’s yield to
the sum of three-month Treasury bills
and the 10-year TIPS breakeven rate
of inflation. Something other than
inflation expectations must be affect-
ing the liquidity premium.
The U.S. is highly dependent on for-
eign investors to fund its massive
trade and budget deficits. While nei-
ther of these deficits affects the dollar
FIGURE 4 — SWISS FRANC VOLATILITY AND U.S. TREASURY YIELD CURVE:
THREE MONTHS - TEN YEARS
as we might think (see “What
The Swiss National Bank has been far less interventionist than the Bank of Japan, pro-
drives the dollar index?” Currency
viding a cleaner picture of its effects on the FRR between three months and 10 years.
Trader, January 2006), the opposite
is not true. A foreign investor in
the U.S. is long the dollar and will
need to sell those dollars at some
point in the future.
Two risk factors arise for the
foreign investor in the U.S. The
first and most straightforward is
the risk of dollar depreciation
over time. That risk, which has
been realized many times over
the entire floating exchange-rate
era, can be hedged using known
techniques and instruments.
The second risk is less straight-
forward but just as real: high cur-
rency volatility. Even within a long-term static trend, such for bond investors that risk must be accounted for in lower
as the one between the dollar and the Japanese yen between prices and higher yields.
late 1999 and mid-2008, higher volatility raises the disper- If this is indeed the case, we should be able to see some
sion of outcomes for the ultimate repatriation of funds — measure of a long-term relationship between the liquidity
that is, higher currency volatility is a risk for investors, and continued on p. 30
premium and currency volatility. Let’s examine the long- HLC volatility will be mapped against the yield curve
term high-low-close volatility (HLC) for the Japanese yen over three different segments: three months against 10
and the Swiss franc, going back to 1977. Japan has been an years, one year against 10 years, and two years against 10
important creditor to the U.S. for the past three decades. years. The Federal Reserve’s constant-maturity measures
The Swiss franc was chosen because it has a continuous his- from the H15 report are used for the interest-rate data at the
tory uninterrupted by the advent of the Euro. HLC volatil- note horizons.
ity is defined as: The the yield curve’s shape will be normalized by the for-
ward rate ratio (FRR) between the maturity pairs. The FRR
is the forward rate between two bonds divided by the yield
of the longer-dated instrument. For example, the FRR
between two and 10 years is the rate at which we can lock
in borrowing for eight years starting two years from now,
divided by the 10-year rate itself. The more a FRR exceeds
where N is the number of days between 4 and 29 that
1.00, the steeper the yield curve is; a FRR less than 1.00
minimizes the function:
denotes an inverted yield curve.
The yen and the yield curve
Much of the trade in the yen during recent years has been
driven by the yen carry trade, the borrowing of low-interest
yen to lend elsewhere (see “A closer look at the carry
trade,” Currency Trader, June
FIGURE 5 — SWISS FRANC VOLATILITY AND U.S. TREASURY YIELD CURVE 2007). Whenever the Bank of
Japan threatens to tighten credit
The FRRs starting at one and two years track Swiss franc HLC volatility similarly to yen
or whenever the world’s
HLC volatility. The relationship during the bullish 2007-2008 steepening is especially strong.
investors flee risk, as happened
in late 2008 and early 2009, the
yen strengthens and its volatility
A policy response by the
Federal Reserve often is associat-
ed with this trade; it certainly
was after the onset of the credit
crunch in August 2007. This is
not, however, a rule. Yen volatili-
ty spikes during the late 1980s, in
1995, and during the 1998 Long
Term Capital Management crisis,
occurred within the context of a
flattening yield curve. Both the
Federal Reserve and the Bank of
Japan were trying either to stem
the dollar’s slide, the yen’s rise,
or both, during these episodes.
Let’s map the yen’s HLC
volatility against the three FRRs
mentioned above. First, let’s look
at the FRR between three-month
Treasury bills and 10-year
Treasury notes (Figure 2). Three
periods of a bearish steepening
continued on p. 32
30 June 2009 • CURRENCY TRADER
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of the yield curve — that is, a steeper yield curve driven by 2008, respectively). Because the franc is a funding currency
rising long-term rates — are marked with green lines. A for carry trades, its HLC volatility rose after the onset of the
fourth, marked with a turquoise line, is the 2007-2008 bull- 2007 credit crunch as these positions were unwound.
ish steepening. All are associated with increases in yen HLC As the Swiss National Bank has been far less interven-
volatility. tionist over the years than the Bank of Japan, we should get
We should not expect the effect to be as pronounced dur- a cleaner picture of its effects on the FRR between three
ing bearish steepenings for the other two FRRs, those months and 10 years, and we do (Figure 4). The same com-
between one- and two-year notes on the short end and 10- ments made for yen HLC volatility apply and the chart is
year notes on the long end (Figure 3): If 10-year note yields marked identically to Figure 2.
are rising during periods of rising inflation, rising econom- In Figure 5, the FRRs starting at one and two years track
ic growth or both, the incentives to maintain yen carry franc HLC volatility similarly to yen HLC volatility in
trades are high. However, we should expect yen HLC Figure 3, and for the same reason. The relationship during
volatility to rise during a bullish steepening, one defined by the bullish steepening of 2007-2008 is especially strong.
a change in American monetary policy and one where the
dollar’s interest-rate advantage to the yen may be decreas- Implications for long-term Treasury returns
ing. That is the case for both of these FRRs. If rising currency volatility steepens the yield curve and if
the best time to buy bonds is when the yield curve is flat to
The Swiss franc inverted, it should stand to reason a combination of high
and the yield curve currency volatility and a steep yield curve should lead to
The Swiss franc’s HLC volatility history has differed con- poor returns on 10-year Treasury notes.
siderably from the yen’s. It reached its highs during the We can gauge this effect visually by mapping three-
strong inflation of the late 1970s and early 1980s as the month-ahead returns on 10-year T-notes against the three
world sought refuge in the franc, so much so the Swiss FRRs and each currency’s HLC volatility. In Figure 6, posi-
imposed an interest-rate penalty on foreign deposits (see tive returns are marked with blue bubbles and negative
“Franc-ly my dear, I don’t give a carry,” and “The Swiss with white; the size of each bubble corresponds to the mag-
franc’s commodity connection,” September and October continued on p. 34
FIGURE 6 — THREE-MONTH AHEAD PERCENTAGE RETURNS ON TEN-YEAR TREASURIES:
AS FUNCTION OF JAPANESE YEN AND SWISS FRANC VOLATILITY AND FORWARD RATE RATIO
Positive returns are marked with blue bubbles, negative returns with white; the size of each bubble represents the magnitude
of the return.
32 June 2009 • CURRENCY TRADER