NEW YEARS FX: CURRENCIES POISED TO MOVE P.

6
Strategies, analysis, and news for FX traders

January 2014 Volume 11, No. 1

Is 2014 really the year of the buck? p. 12 Following the butterflies p. 22 Behind the recent dollar weakness p. 17 British pound: Breakout or breakdown? p. 19

CONTENTS

Contributors..................................................4 Global Markets FX 2014: Old friends and new trends.........6

The Feds tapering process will likely dominate forex dynamics as the new year gets underway, initiating some new moves and sustaining others that have already established themselves. By Currency Trader Staff

Global Economic Calendar......................... 28

Important dates for currency traders.

Events ........................................................28
Conferences, seminars, and other events.

Currency Futures Snapshot.................. 29 BarclayHedge Rankings......................... 29

Top-ranked managed money programs

On the Money The Year of the Dollar?............................. 12

The deflation issue looms large in the forex picture for the new year. By Barbara Rockefeller

International Markets............................. 30
Numbers from the global forex, stock, and  interest-rate markets.

Recent dollar weakness is really Euro and pound strength.................................. 17

A survey of recent moves in the forex world. By Marc Chandler

Spot Check Brit pound flirts with resistance (again)..................................... 19

The pound/dollar pair is poised to challenge the upper boundary of a longer-term trading range. Does it have the momentum to break through it? By Currency Trader Staff

Looking for an advertiser?

Click on the company name for a direct link to the ad in this months issue. Ablesys FXCM Traders Expo

Advanced Concepts Butterflies are free, and well worth it: The minors................................................ 22
Concluding last months analysis, we look at the relationship between butterflies and currency moves. By Howard L. Simons

Questions or comments?
Submit editorial queries or comments to webmaster@currencytradermag.com
2 January 2014 CURRENCY TRADER

CONTRIBUTORS

A publication of Active Trader

For all subscriber services:

www.currencytradermag.com

Editor-in-chief: Mark Etzkorn metzkorn@currencytradermag.com Managing editor: Molly Goad mgoad@currencytradermag.com Contributing editor: Howard Simons

q Howard Simons is president of Rosewood Trading Inc. and a strategist for Bianco Research. He writes and speaks frequently on a wide range of economic and financial market issues.

Contributing writers: Barbara Rockefeller, Marc Chandler, Chris Peters Editorial assistant and webmaster: Kesha Green kgreen@currencytradermag.com

q Barbara Rockefeller (www.rts-forex.com) is an international economist with a focus on foreign exchange. She has worked as a forecaster, trader, and consultant at Citibank and other financial institutions, and currently publishes two daily reports on foreign exchange. Rockefeller is the author of Technical Analysis for Dummies, Second Edition (Wiley, 2011), 24/7 Trading Around the Clock, Around the World (John Wiley & Sons, 2000), The Global Trader (John Wiley & Sons, 2001), The Foreign Exchange Matrix (Harriman House, 2013), and How to Invest Internationally, published in Japan in 1999. A book tentatively titled How to Trade FX is in the works. Rockefeller is on the board of directors of a large European hedge fund. q Marc Chandler (marc@terrak.com) is the head of global foreign exchange strategies at Brown Brothers Harriman and an associate professor at New York Universitys School of Continuing and Professional Studies. Chandler has spent more than 20 years analyzing, writing, and speaking about global capital markets. He is the author of Making Sense of the Dollar: Exposing Dangerous Myths about Trade and Foreign Exchange (Bloomberg Press, 2009).

President: Phil Dorman pdorman@currencytradermag.com Publisher, ad sales: Bob Dorman bdorman@currencytradermag.com Classified ad sales: Mark Seger seger@currencytradermag.com

Volume 11, No. 1. Currency Trader is published monthly by TechInfo, Inc., PO Box 487, Lake Zurich, Illinois 60047. Copyright 2014 TechInfo, Inc. All rights reserved. Information in this publication may not be stored or reproduced in any form without written permission from the publisher. The information in Currency Trader magazine is intended for educational purposes 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.

January 2014 CURRENCY TRADER

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GLOBAL MARKETS

FX 2014: Old friends and new trends

The Feds tapering process will likely dominate forex dynamics as the new year gets underway, initiating some new moves and sustaining others that have already established themselves.
BY CURRENCY TRADER STAFF

With 2013 in the rearview mirror, economists are seeing signs the global economy is finally picking up speed. With global gross domestic product (GDP) estimated around 2.9-3% for last year, forecasts are brighter for 2014 in the 3.5-3.7% ballpark. Overall, global inflation remains low perhaps even too low with lackluster wage growth and flagging commodity prices. Expectations that developed nations and regions, including the U.S., UK, Japan, and the Eurozone, will register stronger growth this year is a major contributing factor to the anticipated pickup in global growth. Credit Suisse estimates developed markets will grow at a 2.1% pace in 2014 vs. 1.1% in 2013. [In] the last three to six months, developed nations have taken on a better tone in outlook, says Cary Leahey, senior advisor to Decision Economics. He describes the 2014 global economic outlook as reasonably positive. However, emerging market growth is expected to far outpace GDP growth in developed nations in 2014. Credit Suisse forecasts a 5.3% emerging market GDP pace.

Eurozone

After two years of negative GDP, the Eurozone is expected to pull out of recession with a 1.3% growth rate in 2014, according to Credit Suisse. Moodys Analytics forecasts slightly slower growth (1.1%) in 2014, with variations within the member countries. Countries with less public and private debt, such as Germany and Austria, will grow faster, while those with heavier debt burdens, such as Spain and Greece, will grow slowly or contract, says Petr Zemcik, director of economic research at Moodys Analytics. Despite the improvement, the Eurozone still faces headwinds. The risk of a Eurozone breakup has subsided in
6

the short term now that the area is growing modestly, Zemcik says. But the source of this growth is mainly external because Eurozone countries increasingly rely on exports. As a result, he says, Eurozone growth is vulnerable to a slowdown in emerging markets. Zemcik adds the unemployment rate is still alarmingly high in the troubled economies that have received external fiscal help. Although these countries current account balances improved and labor costs declined, their growth is subpar with the exception of Ireland because of the high level of overall debt and the risk of deflation, he says. Also, while a dissolution of the European currency union appears less likely than it did a year or two ago, that risk has not been entirely erased. A potential breakup of the currency union remains the greatest risk to the economy, Zemcik says. The regions fiscal compact took effect, but Greeces parliament disregarded the new rules by failing to seek approval from the IMF and European Commission for its 2014 budget. Meanwhile, the European Central Bank (ECB) will begin regulating 130 institutions in the Eurozone, while Germany and the European Commission may reach a compromise over the banking unions format, Zemcik says. For example, Germany will allow the Commission a role in bank restructuring as long as no significant funding is required, he explains.

U.S.

The U.S. economy is showing upward momentum as well, with moderate improvement in the labor market and a surprisingly strong (4.1%) Q3 GDP reading. Credit Suisse forecasts a 2.6% GDP rate for 2014, up from 1.7% in 2013. Wells Fargo pegs 2014 GDP at 2.4%.
January 2014 CURRENCY TRADER

The U.S. should have stronger growth, says Jay Bryson, global economist at Wells Fargo. Things continue to pick up and the financial crisis continues to recede. He notes the economy isnt completely healed. U.S. consumers still have holes in their balance sheets, he says. Their real capital net worth hasnt gotten back to where it was in 2007. But if this were a baseball game, wed be in the seventh inning. Leahey sees better confidence, manufacturing, and a reduced chance of fiscal mishap as positive factors for U.S. economic growth this year. The improved economic signals opened the door to the Federal Reserve tapering in January. The Fed announced in December that beginning this month, it will shave $10 billion off its monthly bond purchases, which have been intended to stimulate the economy. The tapering process is expected to continue throughout 2014, with the Fed potentially eliminating its monthly asset purchases by the end of the year. However, analysts do not expect a change in the fed funds rate in 2014, and the Fed has said as much. As we progress throughout the year, people will wonder how fast tapering will go and how fast they will raise interest rates, Bryson says. We think 2015, but if data comes in stronger early in the year, people will start to price in Fed tightening earlier.

Expectations that developed nations and regions will register stronger growth this year is a major contributing factor to the anticipated pickup in global growth.
China

at Bank of Toyko-Mitsubishi, expects to see more of the same from the BOJ. There are no new arrows to pull out of the hat for Japan, he says. A sales tax increase is set to go into effect in April, and the impact will be closely watched. We are hopeful they can raise taxes a little bit and it will not send the economy spiraling downward, Rupkey says.

China is expected to mostly hold steady in 2014, with a 7.7% GDP forecast following 2013s 7.6% pace, according to Credit Suisse. They have finally reached a slower glide path in the 6.5-7.5% range, Leahey notes. However, the Chinese outlook is risk-laden, according to some economists. Bryson says that although a soft landing is expected, a more significant economic slowdown carries the risk of social instability. There are also questions about the health of financial institutions in China. Banks have lots of losses, Leahey says. There is the possibility of an overseas banking crisis.

Latin America

Japan

Japans economy is also boasting a minor pick-up in growth, which could be a response to a massive quantitative easing and fiscal policy response. Credit Suisse forecasts 2.2% GDP for Japan in 2014, after a 1.8% reading in 2013. Japan has a shot at finally escaping deflation, Leahey says. Japan employed a significant and far-reaching monetary and fiscal policy program last year led by Bank of Japan (BOJ) Governor Haruhiko Kuroda. He has engaged in an extensive and sustained asset buying program, says Glenn Levine, senior economist at Moodys Analytics. This has helped to push down the value of the yen, which has fallen by a third against the U.S. dollar since October 2013, when it became clear that Prime Minister Shinzo Abe would win the election. Looking into 2014, Chris Rupkey, managing director
CURRENCY TRADER January 2014

The Latin region is also expected to show an increase in GDP in 2014. Moodys Analytics estimates the growth rate at a 3.5% pace, up from 2.6% in 2013. According to Alfredo Coutino, director Latin America for Moodys Analytics, Brazil and Mexico represent 60% of Latin Americas total GDP and gains in those two key economies are expected to boost the regions output. After a 2.4% GDP rate in 2013, Brazil is expected to see an uptick to 3% in 2014, according to Credit Suisse. Also, China now plays a key role in Latin American economies. China is the main trading partner with Brazil, Argentina, Chile, and Colombia, Coutino says. These South American countries have more diversified markets for exports, and they dont depend exclusively on the U.S. market. There has been a great deal of discussion in recent months regarding the impact on emerging markets of Fed tapering and policy normalization. Much of the liquidity from the Feds easy money policies has landed in emerging markets in recent years.
7

GLOBAL MARKETS

FIGURE 1: EURO/U.S. DOLLAR

Currencies were getting strong in part because global liquidity was getting to those currencies, Coutino says. Now that the Fed will start withdrawing liquidity, some of those investments will leave Latin America. The likely result, Coutino says, is Latin American currency depreciation. Two to three years down the road, though, he says the weakened currencies will ultimately benefit Latin America because it will make their exports more competitive on the global market.

Currencies to watch
Although a long dollar position isnt a lock trade, most analysts see upcoming weakness in the EUR/USD pair.

FIGURE 2: DOLLAR/YEN

The already-depreciated yen is expected to weaken even more vs. the dollar, resulting in a rising dollar/yen rate.
8

What does all this mean for the forex markets in 2014? One key trend most market watchers expect to see is strength in the U.S. dollar because of the start of Fed monetary policy normalization. We are positive on the dollar over the next year, says Vassili Serebriakov, FX strategist at BNP Paribas. The Fed will be winding down its asset purchases and that will keep the rising trend in U.S. yields intact and support the U.S. dollar. As the Fed gradually exits monetary policy, we will see the dollar strengthen, particularly vs. the Euro, Japanese yen, and Swiss franc. All of those currencies have dovish central banks in place, and we expect the ECB to ease further. The short EUR/USD trade is one of BNP Paribas top FX trade ideas for 2014, with a target of 1.2500 (Figure 1). Another pick is long USD/JPY, with a target of 118 (Figure 2). The contrast between Fed policy and the BOJ will increasingly become apparent, which should drive dollar/
January 2014 CURRENCY TRADER

FIGURE 3: BRITISH POUND yen higher, Serebriakov explains. Another currency to watch, according to Serebriakov, is the British pound. We like sterling. We expect the UK economy to be strong, he says. However, his firm advises keeping the U.S. dollar out of the equation and instead look at a short EUR/GBP trade, with a target of 0.7800 (Figure 3). The Bank of England wont be hiking rates until 2015, but as the economy improves there, expectations will pick up and Eurozone growth will be soft, he says.

New year

While the Fed has widely broadcast Although the British pound has some bullish fundamentals, the trade is probably its expected monetary policy course in best attempted vs. the Euro rather than the dollar. 2014, there is an important point forex traders should keep in mind in the new trading year. One key difference for FX markets FIGURE 4: CURRENCIES DOWN UNDER in 2014 is that its unlikely there will be as stunning a monetary policy change as the BOJs big bang of April 2013, which made short yen a winner on any number of crosses, says Sean Callow, senior currency strategist at Westpac Institutional Bank. Any change in BOJ policy in 2014 will be far less dramatic. Callow also sounds a note of caution regarding a one-way perspective on the U.S. dollar. The Yellen Fed is unlikely to provide a simple USD trade for the year, he says. Investors loading up on dollars in excitement over the expected further unwinding of quantitative easing should be wary of the hurdles ahead. These include the patchy relaRelative weakness in the Aussie dollar vs. the New Zealand dollar has some tionship between the dollar and perianalysts looking at a long AUD/NZD trade. ods of QE and periods of Fed balance sheet stability, the likelihood the Feds report: The rapidly falling Australian dollar should start forward guidance will keep a lid on long-term yields, and to benefit the Australian economy through 2014. Iron ore the risk that the U.S. economy will again fail to reach the hoped-for 3% growth pace, which it has not achieved since exports are due to rise sharply as more production comes online, 2005. The report also argued an early start to the Reserve Nonetheless, one of Westpacs top trades for the first Bank of New Zealands tightening cycle could soften the quarter of 2014 is to sell the EUR/USD at 1.40, targeting nations housing market, and that significant corporate a run to 1.33. A second Q1 trade idea is to buy the Aussie demand for AUD/NZD was likely around last decades dollar/New Zealand dollar pair (AUD/NZD) around lows. 1.05 (Figure 4). As noted in Westpacs Top Trades for Q1
CURRENCY TRADER January 2014 9

GLOBAL MARKETS

U.S. dollar should be a strong performer, especially in the first half of the year. Bennenbroek also holds a favorable outlook on the New Zealand dollar. GDP is quite strong, business confidence is very high, he says. The Reserve Bank of New Zealand is likely to raise its policy rate amid the quite solid pace of growth. The markets are expecting to see a hike in the first quarter. FIGURE 5: NEW ZEALAND DOLLAR Bennenbroek pegged a target of .8500 for NZD/USD [by the end of the year], and .8600 in 18 months (Figure 5). Bennenbroek believes emergingmarket currencies could be susceptible to weakness during the initial phase of Federal Reserve adjustment, but looking farther out he sees the potential for the Mexican peso (MXN) to strengthen over the medium term (Figure 6). Their current account deficit is relatively modest, he notes. To date, Mexico hasnt had trouble attracting capital flows to finance that deficit. There is some positive sentiment because of their reforms most notably the increased access by foreign companies to Mexicos oil industry. Bennenbroek has a 12-month target Anticipated rate increases by New Zealands central bank is one reason analysts of 12.90 for the USD/MXN pair and an see the potential for NZ dollar strength. 18-month target of 12.70. Although the yen has already weakened significantly over the past year, FIGURE 6: MEXICAN PESO many analysts expect more of the same this year given the BOJs ongoing quantitative easing. One of the main themes for 2014 includes the rotation of liquidity from the Federal Reserve to the Bank of Japan, and that has already gotten underway, says Richard Cochinos, head of America G-10 FX strategy Citigroup. One of my strongest views is that we will see dollar/yen significantly higher at the end of the year, in excess of $1.20. Cochinos adds that so-called commodity currencies, specifically the Canadian and Australian dollars, face pressure because of their dovish central banks. He sees a 50% chance the Aussie dollar/U.S. dollar could reach Although emerging-market currencies could be susceptible to weakness during .8000 by year-end. y

Fed focus

Nick Bennenbroek, head of currency strategy at Wells Fargo, also sees the U.S. Fed as a key engine for the FX market this year. The Feds continuing policy actions will be the most important driver in 2014 he says, forecasting a 12-month target of 1.2800 for the Euro/dollar pair. The

the initial phase of Federal Reserve adjustment, some analysts think the Mexican peso (MXN) could strengthen over the medium term.
10

January 2014 CURRENCY TRADER

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On the Money ON THE MONEY

The Year of the Dollar?

The deflation issue looms large in the forex picture for the new year.
BY BARBARA ROCKEFELLER

The FX world is divided into two camps regarding 2014. The first camp holds the relative spread scenario rising rates in the U.S. and steady or falling rates everywhere else, including Europe and Japan will favor the dollar. A Bloomberg survey in December found an overwhelming majority of FX economists favor this point of view. In this scenario the Euro will fall to an average of 1.2800 during 2014. In contrast, other analysts see the Euro as the likely winner, rallying back to 1.4000 for the first time since October 2011, on the basis that U.S. rates are not, in fact, going up. Despite the FOMC decision in December to taper its purchases of Treasuries and mortgage-backed securities starting this month, the market has come to believe the Feds
Barbara Rockefeller Currency Trader Mag Jan 2104 Fig 1: Euro (Green) vs. 10-Year Note Yield Index
30.3 30.2 30.1 30.0 29.9 29.8 29.7 29.6 29.5 29.4 29.3 29.2 29.1 29.0 28.9 28.8 28.7 28.6 28.5 28.4 28.3 28.2 28.1 28.0 27.9 27.8 27.7 27.6 27.5 27.4 27.3 27.2 27.1 27.0 26.9 26.8 26.7 26.6 26.5 26.4 26.3 26.2 26.1 26.0 25.9 25.8 25.7 25.6 25.5 25.4 25.3 25.2 25.1 25.0 24.9 24.8 24.7 24.6 24.5 24.4 24.3 12 13 19 26 2 9 September 16 23 30 7 October 14 21 28 4 11 November 18 25 2 9 December 16 23

forward guidance message of lower for longer. Figure 1 shows that after a rate-cut shock in early November, the Euro reversed to an uptrend at the same time U.S. yields were also rising. This is backwards. The currency with rising rates should be getting the boost, not the currency that just had a rate cut and is likely to get more. In addition, the divergence in rates is warranted by relative growth rates. In Q3, the Eurozone had growth of -0.4% while the U.S. was steaming along at 4.1%. But growth is only roughly correlated with currency performance. History tells us the dollar can stay weaker longer than both relative spreads and comparative growth would imply. Is it different this time?

FIGURE 1:  EURO (GREEN) VS. 10-YEAR NOTE YIELD INDEX

1.385

Inflation, deflation, and secular stagnation

1.380

1.375

1.370

1.365

1.360

1.355

1.350

1.345

1.340

1.335

1.330

1.325

1.320

1.315

1.310

1.305 30 2014 6

After the shock of a rate cut in early November, the Euro reversed to an uptrend while U.S. yields were also rising.
Source: Chart Metastock; data Reuters and eSignal

It would take significantly higher yields and seriously superior growth to overcome the long-standing bias against the dollar. The longstanding bias in favor of the Euro, on the other hand, is not a straight line; it takes the form of powerful upward thrusts after spiky lows, as we saw in October 2008, June 2010, and July 2012 (Figure 2). The Euro has retraced as much as 50% of its 2000-2008 uptrend, and at year-end 2013 it was about 30% below the highest peak (1.6038 from July 2008). In fact, the Euro faces long-term resistance around 1.3860 and notice that the 200-period moving average in Figure 2 is essentially horizontal. It might be outdated to speak of a long-standing bias in favor of the Euro. Whether Europe is going to experience a bout of deflation is one of the biggest questions of 2014. The European Central Bank (ECB) took the unexpected step of cutting rates in November from 0.50% to 0.25% with a nod to a protracted period of low inflation, but ECB
January 2014 CURRENCY TRADER

12

FIGURE 2:  EURO, MONTHLY

1.60 0.0%

Barbara Rockefeller Currency Trader Mag Jan 2104 Fig 2: Euro, Monthly

1.60 1.55 1.50 1.45

1.55

1.50

1.45 23.6% 1.40

1.40 1.35

1.35 38.2%

1.30

1.30 1.25

1.25 50.0%

1.20 Chief Mario Draghi has maintained all along the 1.15 Eurozones long-term inflation expectations are 1.10 firmly anchored and will move up gradually. 1.05 Draghi turned the sovereign debt crisis around 1.00 with a single phrase whatever it takes 0.95 and after that, no one has liked to gainsay him. 0.90 But an institutional commitment to take action 0.85 is a very different than an economic forecast. In 0.80 the Economic and Monetary Union (EMU) infla1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 tion is rising at a rate of less than 1%, and even The long-standing bias in favor of the Euro had taken the form of in Germany its only 1.2%, the same as in the powerful upward thrusts after spiky lows e.g., October 2008, June U.S. Deflation is rampant in the hardest hit of 2010, and July 2012. the sovereigns, Greece and Cyprus, and is only logical as economic activity contracts in some other countries (Spain, Portugal, Netherlands, France). The only OECD country with any inflation is the Maynard Keynes, although he didnt call it that. When the UK, and even there it has fallen back to 2.5%. In Europe, risk-adjusted return on assets falls to zero or below, hoardthe producer price index (PPI) is at -1.4% and money suping is the outcome, which can lead to a liquidity trap or ply growth is only about 1.9%, far below the ECB target of to shortages that goose the production cycle back into gear. 4.5%. Options like central banks charging banks for stashing So far theres no indication the ECB will be as aggrescash instead of paying them for reserves, or banks changsive in fighting deflation as it was when fighting inflation, ing depositors on cash balances, lack credibility and are and in any case the looming bank capital adequacy and too bold for a public that doesnt really understand how stress-test ordeals are a potent countervailing force. As the monetary system works. in the U.S., the central bank shoving liquidity down the Although it sounds counterintuitive, some analysts throats of the banks is not likely to overcome the banking think raising rates are more likely to boost production as sectors rebalancing and pullback. The ECB cannot execute companies scurry to get ahead of additional increases. This quantitative easing per se, but even if it could, QE does not amounts to counting on self-fulfilling expectations and has necessarily raise money supply and, in turn, inflationary never really been attempted. tendencies. It has not done so in the U.S., where money Another issue is the export of deflation by China. supply growth is flat after a tepid rise in 2011 and 2012. Chinese fixed capital investment is running at a rate of Deflation is a funny thing, and not well understood. A about $4 trillion annually, more than any other country, key reason is the connection between the real economy and growing faster than in any other country or region. All (including capital investment) and interest rates is so odd. this investment has pushed up the cost of raw materials, In the U.S., for example, corporations are sitting on about including many commodities, but has also resulted in high $2 trillion in surplus cash, with as much as $1 trillion exports (and the resulting rise in FX reserves). Nothings stashed abroad. Conventional wisdom dictates that ultracertain yet, but this could be the good deflation arising low rates of return on that cash should push companies from excess supply, as deflationists such as Gary Shilling into capital investments holding out the promise of a high- point out. er return. But thats not happening, presumably because Good deflation also arises from improvements in procompanies survey their customers for rising demand ductivity, which is turn are nurtured by technological and dont see it. The answer, historically, is technological advances in production. In contrast, bad deflation arises innovation that inspires demand and thus production of from insufficient demand (as we suffered after the housing supply. So far, we have Twitter instead of railroads, autobust), as characterized by the Japanese economy for two mobiles, TVs, and PCs. decades. Probably the most sensible explanation is the riskNow along comes former Treasury Secretary Lawrence analysis version, which was actually pioneered by John Summers, who says the U.S. and perhaps the world is
1.20 1.15 61.8% 1.10 1.05 1.00 0.95 0.90 0.85 100.0% 0.80

CURRENCY TRADER January 2014

13

ON THE MONEY

entering a period of secular stagnation, a term that means endless deflation against which a central bank is powerless. When prices are falling, the real interest rate is rising. After all, the real rate is the nominal rate minus inflation, so if the nominal rate is, say, 2% and inflation is -1%, the real rate is 3%. But when the nominal rate is already zero and inflation is negative, the central bank is up a tree. It can keep the nominal rate at zero forever, but measures to boost production belong mainly in the fiscal sphere and historically, boosting production has come about as a shock accompanying war. The U.S. has had long periods of deflation, including much of the 19th century up until the Civil War and during the 1930s ahead of World War II. Theres a bias in finance to worry about inflation rather than deflation, although deflation can be seen to be as normal as any other state of affairs. There are two shocking things about the Summers thesis, the first of which is that he sees secular stagnation as a new normal that lasts a very long time. The second is that Nobel-winning economist Paul Krugman agrees with Summers. The policy implications are mind-boggling and involve politically unpalatable solutions, such as accepting and even promoting bubbles, massive fiscal expansion, and even government sponsorship of scientific research. For Europe, the issue of deflation is especially acute because debt-laden economies see a rise in the real value of the debt. The greater the deflation rate, the higher the real interest rate and the more difficult it is for borrowers to service the debt. When the borrower is a company borrowing from a bank, banks withdraw lending to ensure high credit quality and during 2014, to satisfy the ECB bank examiners who are researching the quality of assets to determine capital adequacy and stress capacity. When the borrower is the state, already struggling sovereigns are unable to demonstrate the required falling debt-to-GDP ratios. Deflation is bad for debtors who must repay in more valuable money, while inflation is the debtors friend. And deflation can result in falling real GDP, in which case the debt is actually rising on a shrinking base. In Italy the public debt ratio has risen from 119% to 133% of GDP over the past two years despite austerity. Bottom line: Deflation has the power to nudge some sovereigns back into a debt crisis. So, Mr. Draghi can whistle past the graveyard all he likes, denying deflation, but as the coming year progresses, everyone will be watching the data like a hawk. We can live with disinflation (falling inflation) but at the first hard evidence that deflation is getting a real grip, the Euro
14

could be in trouble. The thinking here gets a little tricky. After all, deflation raises the real value of a currency, so international investors should continue to prefer the Euro, a second sovereign debt crisis or not. But the central bank is duty-bound to promote at least some inflation, as even the inflationobsessed Bundesbank will probably come to agree. Since the banks are the conduit of activity boosts, the ECB will need to be inventive to herd bank lending toward highproductivity areas and consumer spending while continuing to hector governments to make structural changes in areas like labor law and competitiveness.

Chart vs. chart

Which chart will prevail, the short-term chart showing the Euro continuing to rise despite rising U.S. yields, or the long-term chart showing the Euro reaching serious resistance? As postulated before, an all-too possible outcome is stalemate a prolonged, range-bound, sideways move (averaging around 1.3450 over the past 100 days) that is hell for short-term traders. The outcome depends to a large extent on just how much the market believes lower for longer. The tapering announcement after the Dec. 18 FOMC meeting included a clear intention to complete the removal of quantitative easing before the end of 2014, if the economic data permits, with any hike in the fed funds rate delayed until at least mid-2015. If the market really believes this scenario, the yield curve may steepen a bit but not rise much at the longer end, namely the 10-year. The cap would be along the lines of 3.24-3.5% and, as we have seen, a rise of that magnitude is not sufficient to put the dollar at a premium to the Euro. The differential for tenors ranging from two years to 30 years can be viewed here. The lengthy time frame for the yield to provide sustained dollar support can be gauged from Figure 3. Even high and occasionally rising rates, as in 2005-2007, do not support the dollar when other factors are stronger. Yields have been rising since June 2013 but the dollar has not moved proportionately. To depend on this particular rising tide to lift the dollar boat is an iffy proposition.

Risk and China

Another dollar driver is overall global risk aversion, and the prime source for risk aversion could well be China. Many analysts, in addition to scorning the accuracy of official data, worry about how, exactly, China is going to move away from setting rates and more toward greater marketbased rate determination. In December, the Peoples Bank
January 2014 CURRENCY TRADER

of China tried to engineer a tightening and again set off a liquidity crunch like the one that scared markets everywhere last June. The stability of the financial system is in doubt, as mentioned by no less a figure than San Francisco Federal Reserve President John Williams, who said the core problem lies not only in the widely known housing bubble, but also in a giant rise in both corporate and household debt. To get the private sector to deleverage is a tough task in the face of the tightly controlled financial sector, which itself creates systemic barriers to rebalancing the economy. One of those barriers is a too-low rate of return on savings. Here we go off into the world of apparent perversity. Youd think low rates would get households to favor consumption over saving. But the Chinese household preference for savings is more absolute than elastic, so low rates just mean higher amounts saved. Meanwhile, the wildly high rates of capital formation are financed by banks without a Western bankers appreciation for ability to repay. No one knows the true state of non-performing loans in the Chinese banking system. The assumption is that misallocations of capital are vast. At some point the piper must be paid. A one-time crisis is not really in the cards, though, if only because the state has pride and will go to great lengths to disguise fundamental problems in the banking sector. What we might see instead are periodic liquidity crises two in one year is a pretty high number and the Shanghai stock index reflecting loss of confidence from time to time (Figure 4). An economy that is growing at around 8% should not have a stock index that has been in a downtrend for more than four years, especially in the face of Western stock indices making new all-time record highs. There is a basic disconnect here.

Currency Trader Mag Jan 2104 FIGURE 3:  DOLLAR INDEX (GREEN) VS. 10-YEAR Fig 3: Dollar Index (Green) vs. 10-Year Note Yield Index (Weekly), 2000-2013 NOTE YIELD INDEX (WEEKLY), 2000-2013
125 60 120 55 115 50

Barbara Rockefeller

110

45

105

40

100

35

95

30

90

85 25 80 20 75 15 70 10 2000 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2

Yields have been rising since June 2013 but the dollar has not moved proportionately.

FIGURE 4: SHANGHAI STOCK INDEX, WEEKLY

6500 6000

Barbara Rockefeller Currency Trader Mag Jan 2104 Fig 4: Shanghai Stock Index (Weekly)

5500

5000

4500

4000

3500

3000

2500

2000

1500

Commodities

We might want to consider commodities as a bellwether, although commodities like oil, gold, and copper have a pesky habit of volatility for reasons other than supply and demand (Figure 5). Gold, of course, has been on a downtrend since the double top of June and October 2012
CURRENCY TRADER January 2014

1000

2006

2007

2008

2009

2010

2011

2012

2013

2014

An economy that is growing at an approximately 8% clip should not have a stock index that has been in a downtrend for more than four years.

15

ON THE MONEY
Barbara Rockefeller Currency Trader Mag Jan 2104 Fig 5: Gold and Copper (Orange), Futures Basis

FIGURE 5: GOLD AND COPPER (ORANGE), FUTURES BASIS

4.05 4.00 3.95 3.90 3.85 3.80 3.75 3.70 3.65 3.60 3.55 3.50 3.45 3.40 3.35 3.30 3.25 3.20 3.15 3.10 3.05 3.00 2.95 2012 Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 2013 Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 1150 20 1250 1200 1350 1300 1500 1450 1400 1600 1550 1750 1700 1650 1850 1800

Gold has been in a downtrend since the double top of June and October 2012, and copper (orange) has also declined significantly.

(highest high at $1,798.10, futures basis). For all anyone knows, it has not bottomed yet, if only because acknowledgement of deflation has never really gained wide acceptance. Copper is another story. The U.S. has drawn down its entire stockpile of copper, and warehouse supply at the London Metals Exchange (LME) and in Singapore is at an historic low while China is, reportedly, building a vast stockpile. China already consumes about 40% of the worlds copper. Copper traders scratch their heads over sporadic buying by the China Resources Council and try to keep up with intel on stockpiles, with Chinese demand for copper being re-estimated all the time. The recent rise in copper prices was attributed to confidence in Chinese manufacturing growth ahead, as well as the Feds tapering announcement meaning the world is safe for risk. But again, copper prices down about 10% year-over-year is at odds with an economy that is growing at 8%, or the rest-of-the-world growing at all. In the end, we cant deduce much from copper prices, but its a worry.

The base case

The outlook for 2014 is, overall, not that bright. The U.S. will continue to struggle to get growth above approximately 2.25-2.5%, and unemployment will not fall by much. The only bright note in the U.S. economy will be housing, which has now developed upward momentum. In Europe, fear of deflation and any steps the ECB may take to counter deflation will become the theme of the first half but not enough to inspire expectations of any big policy changes, at least not until Mr. Draghi reverses his position and says so out loud. Whatever creeping yield
16

advantage the U.S. has over Europe may not suffice to support the dollar. An authentic dollar rally would take more spread premium than we have a right to expect, assuming the U.S. bond market remains sane. China could provide the trigger for a risk-aversion flight to the dollar, and while conditions may justify such a worry, we will likely be deprived of hard data and distracted by loud and persistent denials of crisis. Unless there is a terrorist event or war, the safe-haven role of the dollar will probably not be a player in 2014. What will really determine whether 2014 is the Year of the Dollar is whether FX traders come to believe in the strong dollar as the base case. The evidence for that lies in the yield spread rising and staying higher as each important data point comes along. Since May 2013, weve seen the bond yield higher and the dollar firmer on favorable data, such as the unemployment and GDP reports released in December. If the 10-year not only gets to 3.25-3.5% but that region becomes the new floor, the dollar will get support. The other factor is the big, fat resistance line on Figure 2. Failure to break through resistance would be a signal nobody would miss. It might be foolish to predict 2014 the Year of the Dollar, but Q1 may turn out to the Quarter of the Dollar. y
Barbara Rockefeller (www.rts-forex.com) is an international economist with a focus on foreign exchange, and the author of the new book The Foreign Exchange Matrix (Harriman House). For more information on the author, see p. 4.

January 2014 CURRENCY TRADER

ON THE MONEY

Recent dollar weakness is really Euro and pound strength

A survey of recent moves in the forex world.
BY MARC CHANDLER

Decembers holiday-thinned activity may have distorted price action, but the general forex theme that has emerged in recent weeks remains very much intact. The U.S. dollars weakness (despite its big jump on Jan. 2), emphasized by the media and various market observers, and is largely confined to the Euro and the British pound, along with a FIGURE 1: EURO

FIGURE 2: BRITISH POUND

few currencies that move in their orbits. Even recently, as the Euro and sterling climbed to twoyear highs, the Japanese yen slumped to a five-year low, and the Australian and Canadian dollars remain pinned near multi-year lows. Eastern and central European currencies have been lifted against the dollar by the rising Euro, but many of the larger accessible emerging-market currencies, including the South African rand, the crisisstricken Turkish lira, and Mexican peso, have not performed well. Also, in the last week or so of 2013, the Thai baht has lost almost as much as the yen. It seems the combination of the large current account surplus, aided by the rebalancing of the European periphery (including Spain), portfolio capital inflows, and the ongoing deleveraging of the financial sector is giving the Euro greater legs than anticipated. At the same time, despite the divergence in the trajectory of monetary policy, the December Eurodollar-Euribor spread stands at an unimpressive 8 basis points. The three-month Euribor was fixed higher than three-month Eurodollar (0.2735% vs. 0.2466%). The thin market conditions appear to have exacerbated the move that was already underway. The Euros push to almost $1.39 in December was exaggerated, and some near-term backing and filling has already taken place. Initial support lies in the $1.3680-$1.3700 area, followed by $1.3600. On the upside, there is increased focus on the trendline connecting the 2008 record high and the May 2011 high. At the start of January, the line comes in around $1.39.20 (Figure 1). Sterling has convincingly violated a similar trendline drawn off the August 2009 high and the April 2011 high (Figure 2). It was approached several times, including during January and October 2013. Any backing and filling should be limited to the $1.6300 area. After a push above $1.6600, the next important technical target is near $1.6750. The losses in the U.S. Dollar Index (DXY) have been mitigated by the dollars strength against the yen and

CURRENCY TRADER January 2014

17

ON THE MONEY

FIGURE 3: DOLLAR INDEX Canadian dollar. DXY rebounded quickly from the drop below the previous months low, leaving it stuck between the up trendline connecting the Oct. 25 and Dec. 18 lows, and the down trendline connecting the Nov. 12-21 highs and the Dec. 20 high. These converging trendlines were around 80.00 and 80.65 on Jan. 3; DXY penetrated the upper line on Jan. 2 (Figure 3). If Euro and sterling strength is a theme, so is the yens weakness, making it difficult to discuss the dollar in general. The dollar/yen (USD/JPY) rate pushed through the 105 level after breaking 104 in the immediate response to the Feds tapering decision on Dec. 18. The next important technical target comes near 110 (Figure 4). The Euro/ yen (EUR/JPY) has not looked back since breaking above 140 on Dec. 6. Its next target is 150. The broadly sideways price action in the Australian dollar failed to improve the technical picture. The Aussie dollar/U.S. dollar (AUD/USD) pairs bounce in the early part of the last week stalled just ahead of the lower end technical resistance we noted in the $0.8970 area. It can be expected to test the $0.8800 in the near term. The next major objective is near $0.8550 (Figure 5). After the yen and Australian dollar, the Canadian dollar has been the third-worst performer against the dollar in Q4. (Toward the end of 2013, the Canadian dollar was weaker than the Aussie dollar.) Look for the U.S. dollar/ Canadian dollar (USD/CAD) to convincingly rally above 1.07. The next immediate technical target is around 1.08, with an anticipated move toward 1.12-1.14 in the coming months. For seven consecutive sessions through Dec. 27, the dollar recorded a higher low against the Mexican peso. Nevertheless, the broad trading range of 12.80-13.10, identified last week, has remained largely intact. Technical indicators are not generating strong signals presently, but if this analysis is accurate and there is some backing and filling technical action in the near term, the dollar is more likely to ease toward the lower end of this narrow range. y
Marc Chandler is head of global foreign exchange strategies at Brown Brothers Harriman. His blog is called Marc to Market (www.marctomarket.com). For more information on the author, see p. 4.

FIGURE 4: YEN

FIGURE 5: AUSSIE AND CANADIAN DOLLARS

18

January 2014 CURRENCY TRADER

SPOT CHECK

Brit pound flirts with resistance (again)

The pound/dollar pair is poised to challenge the upper boundary of a longer-term trading range. Does it have the momentum to break through it?
BY CURRENCY TRADER STAFF

On Jan. 2, the British pound/U.S. dollar pair (GBP/USD) rallied to its highest level since August 2011, capping a 12% rally from its July 2013 low (Figure 1). The move was part of an up thrust in the second half of December that kicked off on Dec. 18 (when the Fed announced its longawaited tapering plan) after a test of support at the high of the October-November consolidation. The first hint of dollar strength and pound weakness came on Jan. 2, when

the pair reversed intraday and fell nearly to the trendline connecting the November and December lows. Figure 2 shows the dollar/pound has now rallied past the resistance implied by its 2012 and early 2013 highs and to the aforementioned 2011 high; the pairs next milestone is the late April 2011 high around 1.6740. Traders familiar with the GBP/USDs longer-term history will know these highs are part of the pairs wide-ranging consolidation dating back to 2009. Figure 3 shows the 2011 high repreFIGURE 1: DAILY POUND/DOLLAR sents the lower end of a resistance zone defined on the upside by the August 2009 high around 1.7000 a level that has arguably functioned as resistance and support as far back as the 1990s. The recent July-January rally has been the pairs largest upswing since the May 2010-May 2011 upswing. Although the U.S. dollar didnt begin rallying immediately when the Fed announced tapering, many analysts have long forecasted renewed strength in the dollar as the Fed begins to normalize monetary policy. Lets look at a few statistics to see whether the pound/dollars current uptrend is likely to negate that outThe GBP/USD pair turned sharply lower on the first trading day of the new look. year, but not before making a new monthly high.

CURRENCY TRADER January 2014

19

SPOT CHECK

FIGURE 2: WEEKLY POUND/DOLLAR

Monthly patterns

The pair has rallied above all its 2012 swing highs.

FIGURE 3: MONTHLY POUND/DOLLAR

The upper end of the pairs resistance zone is defined by the August 2009 high just above 1.7000.

Figure 3 showed the dollar/pound facing obvious chart resistance on the monthly time frame. What does price analysis suggest about the pairs current condition? Table 1 shows how the GBP/USD pair has performed from December to January since 1974. There is a bit of a bearish bias to the statistics. The median change from the December close to the January close was -0.91%; the average was -0.74%. (For comparison, the median close-close moves for all months was 0% and the average was 0.03%.) The median high-to-high move from December to January was -0.29% and the average was -0.04%. The median high-to-high move for all months was -0.10% and the average was -0.04%. January closed lower than December 22 out of 40 years, while it had a higher high than December 21 months out of 40. (The marginally higher high on Jan. 2 of this year means that over the past 41 years, there have been 21 Januaries with higher highs and 20 with lower highs. For all months since January 1974, there have been 240 higher monthly closes vs. 239 lower monthly closes and 226 higher monthly highs vs. 251 lower monthly highs. What about the markets behavior in the months leading up to the recent
January October 2014 2010 CURRENCY TRADER

20

TABLE 1: GBP/USD JAN. TO DEC. MOVES December-January highs? Figure 4 shows the median moves in the pound/dollar pair from one to six months after four price patterns that describe the market through December (or the first trading day of January): 1. Five consecutive higher monthly highs (16 instances) 2. Six consecutive higher monthly highs (nine instances) 3. 24-month high (52 instances) 4. 27-month high (49 instances)
Close-to-close Median Average Median Average -0.91% -0.74% Up 19 Down 21 -0.29% -0.04% Up 18 Down 22

High-to-high

The 24-month and 27-month highs were the only models that produced more than a handful of examples, but the price action after them is a little more bearish (especially in the first three months) than the pound/dollars overall median. The behavior after streaks of five or six consecutive monthly highs, while representing far fewer examFIGURE 4: MONTHLY PRICE PATTERNS ples, is much more bearish, although that bias peaks after two months. (As an aside, other analyzed patterns that also produced 10 or few examples, including a pattern that modeled the pairs rally off the July low through the December high, were also followed by bearish price action.)

the more recent instances have been followed by up moves for at least a few days.) However, the pair is facing significant longer-term resistance, and different models of its recent price behavior imply a potential for weakness. Even for traders expecting a downturn, however, an important question is whether the pair will probe the upper end of its resistance zone before reversing to the downside. y

Stats and fundamentals

The GBP/USD pairs sharp downturn on Jan. 2 doesnt necessarily mean the anticipated dollar strength has kicked in. (Over the past 10 years, 26 instances of days with highs above at least the previous 11 highs, a low below the previous low, and a close in the bottom third of the days range were followed by mixed price action; many of
CURRENCY TRADER January 2014

Most of the price patterns based on monthly data suggest the pound is vulnerable bearish price action.

21

ADVANCED TRADING STRATEGIES CONCEPTS

Butterflies are free and well worth it: The minors

Concluding last months analysis, we look at the relationship between butterflies and currency moves.
BYHOWARD L. SIMONS

FIGURE 1:  THE BRAZILIAN REAL AND THREE-MONTH BUTTERFLIES Last months examination of butterflies and their relationship to major currencies concluded the relative demand for price insurance between currency options out-of-themoney strikes relative to at-the-money strikes did not provide consistent information useful for trading straddles and strangles (see Butterflies are free, and well worth it: The majors, Currency Trader, December 2013). Here well repeat the exercise for a set of minor currencies: the Brazilian real (BRL), Indian rupee (INR), South African rand (ZAR), Turkish lira (TRY), Thai baht (THB), Mexican peso (MXN), and Taiwan dollar (TWD). As a refresher, butterflies are defined as buying both the call and the put of a similar delta and selling two atthe-money options. We generally expect out-of-the-money volatility to be higher as a matter of course to reflect the greater risks involved in writing those options. In practice, however, the smile of volatility often is skewed so that volatility in either the call or put wing is greater than the at-the-money volatility, while the other wings volatility is less than the at-the-money volatility. As in the case of the major currencies, two questions will be asked. First, how do butterflies relate to the carry return from borrowing the USD and lending into the target currency? Here we will map the butterfly values for both
October 2014 January 2010 CURRENCY TRADER

FIGURE 2:  THE MEXICAN PESO AND THREE-MONTH BUTTERFLIES

22

FIGURE 3:  THE INDIAN RUPEE AND THREE-MONTH BUTTERFLIES

three-month 25- and 35-delta against the common logarithm of the total carry return from the U.S. dollar into those currencies, reindexed to January 2006. This depiction allows for the intuitively appealing rising line depicting the stronger currency. Second, do butterflies have any value in trading and market analysis? They should lead the return series if they do. Here well focus on butterflies as a mean-reverting indicator for future absolute returns relative to recent absolute returns.

FIGURE 4:  THE SOUTH AFRICAN RAND AND THREE-MONTH BUTTERFLIES

Butterflies and the minors

With the common and notable exceptions of the 2008 financial crisis and the 2011 U.S. debt ceiling and European sovereign credit situations, butterflies for the Brazilian real have remained within confined ranges (Figure 1). This is not surprising given the reals propensity to trade in long-lived trends. Butterflies on the Mexican peso have followed a pattern that is very similar to the one for the BRL, which is somewhat surprising given the MXNs tendency to switch trends (Figure 2). The abrupt reversals of the past three years might have encouraged higher volatility on the out-of-the-money strikes but clearly failed to do so. The Indian rupee has had a much more mixed picture (Figure 3). The INR posted large and sudden reversals in 2011-2012, and the Reserve Bank was active in first raising and then lowering interest rates in an attempt to quell inflation. Butterflies remained at post-2008 financial crisis levels during this period and then rose during 2013 as the INR broke in response to speculation the Federal Reserve would begin tapering its quantitative easing purchases. For now, the jump in butterfly levels appears to be a singular episode, not the start of a new era in INR trading. Butterflies for the South African rand have followed a different path since the end of the 2008 financial crisis (Figure 4).
CURRENCY TRADER January October 2014 2010

FIGURE 5:  THE TURKISH LIRA AND THREE-MONTH BUTTERFLIES

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ON ADVANCED THE MONEY CONCEPTS

FIGURE 6:  THE THAI BAHT AND THREE-MONTH BUTTERFLIES

FIGURE 7:  THE TAIWAN DOLLAR AND THREE-MONTH BUTTERFLIES

FIGURE 8:  THREE MONTH-AHEAD RETURN SHIFTS FOR THE BRAZILIAN REAL

Regardless of the ZARs trend, which has been lower since June 2011, the path of the 25-delta butterfly has declined with two strong upward spikes. The first occurred in the 2011 U.S. debt ceiling and European sovereign debt crisis and the second arrived in June 2012 in the general absence of volatility either in the rand or in global currency markets in general. Butterflies for the Turkish lira turned erratic in 2013 as the TRY weakened against the USD on interest rate speculation and, more importantly, against the EUR on relative asset returns (Figure 5). Much of the TRYs carry return in recent years has derived from its wide interest rate spreads vis--vis the USD and EUR. Once those high rates start to affect economic growth and relative asset returns, they become reflected in a noisy 25-delta butterfly. The Thai bahts butterflies follow a unique pattern (Figure 6). The 25-delta butterfly spiked higher in March 2008 as the THBs carry return was starting to decline. Once that episode passed, the THB moved through the 2008 financial crisis with relatively little volatility and started to trend higher. The pattern shifted to lower 25-delta butterflies in 2013 even as the carry into the baht weakened; few currency options markets are able to see past short-term trends this way. Finally, the Taiwan dollars butterflies have traded in a low and narrow range, with the common exceptions of the 2008 financial crisis and the 2011 U.S. debt ceiling and European sovereign debt situations (Figure 7). Butterflies expanded in mid-2013 in anticipation of a TWD weakness that failed to materialize.

Prospective returns

Now lets see whether absolute three month-ahead return shifts appear to be a function of these butterflies and of the forward rate ratio between six and nine months (FRR6,9)
24 24 October January 2010 2014 CURRENCY CURRENCY TRADER TRADER

FIGURE 9:  THREE MONTH-AHEAD RETURN SHIFTS FOR THE MEXICAN PESO

for the major currencies (see Minor currencies less affected by Great LIBOR Kerfuffle, July 2013). The FRR6,9 is the rate at which borrowing can be locked in for three months starting six months from now, divided by the nine-month rate itself. The steeper the yield curve, the more this ratio exceeds 1.00; an inverted yield curve has an FRR6,9 less than 1.00. Prospective return shifts will be defined as the absolute average daily return for the next three months minus the average absolute daily return for the previous three months. The goal is to see whether 25-delta butterflies, which measure the difference between out-of-the-money and at-the-money volatility, lead changes in absolute return levels. If so, traders can use them to employ trading strategies such as straddles or strangles, both of which are bets on large or small absolute movement in either direction, respectively. In Figures 8-14 positive absolute return shifts are depicted with green bubbles, negative with red bubbles; the diameter of the bubble corresponds to the absolute magnitude of the return. The last datum used is highlighted and the current environment is marked with a crosshair. In the case of the Brazilian real, the results are very interesting for 25-delta butterfly levels over 1.75% and 25-delta butterfly levels below 1.00% in a positively sloped yield curve environment (Figure 8). In both cases the butterflies suggest mean-reversion is operating; selling strangles is indicated for the high butterfly levels and buying straddles is indicated for the low butterfly levels. The Mexican peso appears even more amenable to these mean-reverting trading strategies (Figure 9). Here 25-delta butterflies in excess of 1.25% generally are followed by negative return shifts; the opposite is true for 25-delta butterfly levels less than 0.50%. Now the results start to become more mixed. The Indian
CURRENCY TRADER January October 2014 2010

FIGURE 10:  THREE MONTH-AHEAD RETURN SHIFTS FOR THE INDIAN RUPEE

FIGURE 11: T  HREE MONTH-AHEAD RETURN SHIFTS FOR THE SOUTH AFRICAN RAND

25

ON ADVANCED THE MONEY CONCEPTS

FIGURE 12:  THREE MONTH-AHEAD RETURN SHIFTS FOR THE THE TURKISH LIRA

FIGURE 13:  THREE MONTH-AHEAD RETURN SHIFTS FOR THE THAI BAHT

FIGURE 14:  THREE MONTH-AHEAD RETURN SHIFTS FOR THE TAIWAN DOLLAR

rupee lacks consistent patterns of return shifts as a function of butterfly levels even when adjusting for different levels of the yield curve (Figure 10). The situation is similar for the South African rand, even though the positive and negative prospective return shifts are clustered strongly (Figure 11). The alternating clusters suggest the effects are too anecdotal or perioddependent to be of much use in developing a trading strategy. The Turkish liras patterns are jumbled across both 25-delta butterfly levels and FRR6,9 levels (Figure 12). No consistent pattern of mean-reversion is evident. The Thai bahts pattern is of little use as well (Figure 13). Even though the exaggerated 25-delta butterfly levels of March 2008 were followed by a large cluster of negative return shifts, this appears to be a singular episode. Nothing in the remainder of the data set suggests mean-reverting behavior. Finally, the map for the Taiwan dollar appears to be a random collection of unrelated observations (Figure 14). No mean-reverting trading strategy is evident. At the end of this examination of minor currencies we are left with two currencies, the BRL and MXN, with promising patterns of prospective mean-reversion and five currencies with no such behavior. The net conclusion from the combination of this analysis and last months involving the major currencies is currency butterflies are of little use in setting up mean-reverting position trades. y
Howard Simons is president of Rosewood Trading Inc. and a see p. 4.

strategist for Bianco Research. For more information on the author,

26 26

October January 2010 2014 CURRENCY CURRENCY TRADER TRADER

CURRENCY TRADER January 2014

27

GLOBAL ECONOMIC CALENDAR

January
CPI: Consumer price index ECB:European Central Bank FDD (first delivery day): The first day on which delivery of a commodity in fulfillment of a futures contract can take place. FND (first notice day): Also known as first intent day, this is the first day on which a clearinghouse can give notice to a buyer of a futures contract that it intends to deliver a commodity in fulfillment of a futures contract. The clearinghouse also informs the seller. FOMC:Federal Open Market Committee GDP: Gross domestic product ISM: I nstitute for supply management LTD (last trading day): The final day trading can take place in a futures or options contract. PMI: P urchasing managers index PPI: P roducer price index Economic release (U.S.) GDP CPI ECI PPI ISM Unemployment Personal income Durable goods Retail sales Trade balance Leading indicators Release time (ET) 8:30 a.m. 8:30 a.m. 8:30 a.m. 8:30 a.m. 10:00 a.m. 8:30 a.m. 8:30 a.m. 8:30 a.m. 8:30 a.m. 8:30 a.m. 10:00 a.m.

1 2 3 4 5 6 7 8 9
U.S.: December ISM manufacturing index LTD: January forex options; January U.S. dollar index options (ICE)

20 Hong Kong: October-December 21 Hong Kong: December CPI

employment report Australia: Q4 CPI Canada: Bank of Canada interest rate announcement Japan: Bank of Japan interest rate announcement Mexico: December employment report South Africa: December CPI UK: December employment report U.S.: December leading indicators Canada: December CPI Mexico: Jan. 15 CPI

Germany: December PPI

22
Canada: November PPI U.S.: November trade balance Germany: November employment report Brazil: December PPI UK: Bank of England interest rate announcement ECB: Governing council interest rate announcement U.S.: December employment report Brazil: December CPI Canada: December employment report Mexico: Dec. 31 CPI and December PPI

23 24

10 11 12 13

25 26 27 28 U.S.: December durable goods 29 announcement 30

U.S.: FOMC interest rate

14 France: December CPI 15

U.S.: December retail sales UK: December CPI and PPI U.S.: December PPI and fed beige book U.S.: December CPI Australia: December employment report Germany: December CPI India: December PPI Japan: December PPI U.S.: December housing starts

31

U.S.: Q4 GDP (advance) Brazil: December employment report Germany: December employment report South Africa: December PPI U.S.: December personal income Australia: Q4 PPI France: December PPI India: December CPI Japan: December employment report and CPI

16
The information on this page is subject to change. Currency Trader is not responsible for the accuracy of calendar dates beyond press time.

1 2 3

February

17 18 19

U.S.: January ISM manufacturing index Canada: December PPI

EVENTS
Event: The World MoneyShow Orlando Date: Jan. 29 - Feb. 1 Location: Gaylord Palms Resort and Convention Center, Orlando For more information: Go to www.moneyshow.com Event: The Traders Expo New York Date: Feb. 16-18 Location: New York For more information: Go to www.moneyshow.com Event: The MoneyShow Las Vegas
28

Date: May 12-15 Location: Caesars Palace, Las Vegas For more information: Go to www.moneyshow.com Event: The MoneyShow San Francisco Date: Aug. 21-23 Location: San Francisco For more information: Go to www.moneyshow.com

January 2014 CURRENCY TRADER

CURRENCY FUTURES SNAPSHOT as of Dec. 30

Market EUR/USD JPY/USD GBP/USD AUD/USD CAD/USD CHF/USD MXN/USD U.S. dollar index NZD/USD E-Mini EUR/USD Sym EC JY BP AD CD SF MP DX NE ZE Exch CME CME CME CME CME CME CME ICE CME CME Vol 176.7 119.6 93.1 82.0 55.2 30.1 29.6 19.3 12.0 3.8 OI 222.8 217.6 189.7 114.6 119.7 44.1 106.8 40.7 19.0 4.8 10-day move / rank 0.49% / 14% -1.79% / 63% 1.36% / 50% -1.07% / 11% -0.63% / 40% 0.36% / 0% -1.87% / 90% -0.31% / 15% -1.26% / 33% 0.49% / 14% 20-day move / rank 1.58% / 38% -2.49% / 40% 0.93% / 35% -2.47% / 18% -0.28% / 7% 2.26% / 66% -0.03% / 0% -0.66% / 26% 0.44% / 22% 1.58% / 38% 60-day move / rank 1.31% / 30% -7.48% / 100% 2.24% / 29% -5.25% / 37% -2.99% / 88% 1.38% / 27% 0.86% / 28% -0.12% / 2% -1.13% / 18% 1.31% / 30% Volatility ratio / rank .27 / 48% .32 / 32% .26 / 80% .12 / 0% .32 / 50% .35 / 60% .33 / 30% .33 / 67% .21 / 23% .27 / 48%

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.

The information does NOT constitute trade signals. It is intended only to provide a brief synopsis of each markets liquidity, direction, and levels of momentum and volatility. See the legend for explanations of the different fields. Note: Average volume and open interest data includes both pit and side-byside electronic contracts (where applicable). LEGEND: Volume: 30-day average daily volume, in thousands. OI: 30-day open interest, in thousands. 10-day move: The percentage price move from the close 10 days ago to todays close. 20-day move: The percentage price move from the close 20 days ago to todays close. 60-day move: The percentage price move from the close 60 days ago to todays close. The % rank fields for each time window (10-day moves, 20-day moves, etc.) show the percentile rank of the most recent move to a certain number of the previous moves of the same size and in the same direction. For example, the % rank for the 10-day move shows how the most recent 10-day move compares to the past twenty 10-day moves; for the 20-day move, it shows how the most recent 20-day move compares to the past sixty 20-day moves; for the 60-day move, it shows how the most recent 60-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% means the current reading is smaller than the previous readings. Volatility ratio/% rank: The ratio is the shortterm volatility (10-day standard deviation of prices) divided by the long-term volatility (100-day standard deviation of prices). The % rank is the percentile rank of the volatility ratio over the past 60 days.

BarclayHedge Rankings: Top 10 currency traders managing more than $10 million
(as of 11/30/13, ranked by November 2013 return) November return 7.60% 4.70% 4.51% 2.25% 1.93% 1.63% 1.46% 1.32% 1.20% 1.15% 19.42% 10.63% 3.83% 2.70% 2.24% 1.80% 0.89% 0.87% 0.81% 0% 2013 YTD return 13.32% -1.40% 31.94% 6.96% 0.54% 35.87% 2.72% -0.38% -6.78% -6.43% 77.56% 35.06% -0.44% 3.12% 1.03% 36.13% -18.79% -6.80% -20.10% 9.02% $ Under mgmt. (millions) 484.7 57.0 74.8 30.0 72.1 40.8 62.1 236.7 3000.0 135.0 4.8 4.0 8.4 1.0 1.0 5.4 1.0 3.0 1.1 1.1

Trading advisor 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 Alder Cap'l (Alder Global 20) Cambridge Strategy (Emerging Mkts) 24FX Global Advisors DynexCorp (Currency) Sequoia Capital Fund Mgmt (FX) CenturionFx Ltd (6X) INSCH Capital Mgmt (Kintillo X3) C-View Limited (3X) P/E Investments (FX Aggressive) Premium Currency (Curr. Plus) Investment Capital Adv (Managed Acts) Fornex (Foyle) Orwell Capital (Currency Alpha) Vortex (FX) JP Global Capital Mgmt (Troika I) SMILe Global (Mgmt FX) AG Bisset (Defensive Alpha) Hartswell Capital Mgmt (Apollo) Smart Box Capital (Leveraged FX) Hartswell Capital Mgmt (Athena)

Top 10 currency traders managing less than $10M & more than $1M

Based on estimates of the composite of all accounts or the fully funded subset method. Does not reflect the performance of any single account. PAST RESULTS ARE NOT NECESSARILY INDICATIVE OF FUTURE PERFORMANCE.

CURRENCY TRADER January 2014

29

INTERNATIONAL MARKETS

CURRENCIES (vs. U.S. DOLLAR)

Rank 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 Currency Swiss franc Great Britain pound Euro Russian ruble Indian rupee Chinese yuan Swedish krona Hong Kong dollar New Zealand dollar Canadian dollar Singapore dollar Taiwan dollar South African rand Thai baht Brazilian real Australian Dollar Japanese yen Dec. 27 price vs. U.S. dollar 1.11586 1.63914 1.368505 0.030615 0.016175 0.16337 0.15242 0.128945 0.81654 0.940155 0.788355 0.033215 0.096625 0.030465 0.424215 0.88928 0.00955 1-month gain/loss 1.51% 1.36% 1.05% 0.89% 0.62% 0.15% 0.10% -0.03% -0.59% -0.91% -1.33% -1.64% -2.30% -2.37% -2.83% -2.85% -3.14% 3-month gain/loss 1.57% 2.10% 1.34% -1.45% 0.09% 0.38% -2.13% -0.02% -1.26% -3.01% -1.07% -1.80% -3.54% -4.87% -5.38% -5.07% -5.63% 6-month gain/loss 1.57% 6.58% 4.90% 0.62% -2.59% 1.21% 2.45% 0.04% 5.11% -1.38% 0.30% 0.00% -0.83% -2.71% -6.39% -4.15% -6.65% 52-week high 1.1277 1.6439 1.3802 0.0337 0.0188 0.16360 0.159 0.129 0.8619 1.0166 0.8191 0.0345 0.118 0.0348 0.5137 1.0568 0.0118 52-week low 1.0274 1.4877 1.2798 0.0299 0.0147 0.1583 0.1464 0.1288 0.7704 0.9341 0.7792 0.0326 0.0956 0.0304 0.4082 0.8851 0.00955 Previous 9 1 10 13 8 3 14 2 4 6 7 5 11 12 16 17 15

GLOBAL STOCK INDICES

Country 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 Japan India South Africa Germany Mexico U.S. Canada UK Italy Australia Switzerland France Singapore Brazil Hong Kong
30

Index Nikkei 225 BSE 30 FTSE/JSE All Share Xetra Dax IPC S&P 500 S&P/TSX composite FTSE 100 FTSE MIB All ordinaries Swiss Market CAC 40 Straits Times Bovespa Hang Seng

Dec. 27 16,178.94 21,193.58 45,735.28 9,589.39 42,753.22 1,841.40 13,588.00 6,750.90 18,956.50 5,323.80 8,221.90 4,277.65 3,149.76 51,267.00 23,243.24

1-month gain/loss 4.72% 3.79% 2.63% 2.55% 2.10% 1.89% 1.69% 1.52% 0.17% -0.02% -0.29% -0.36% -0.70% -1.15% -2.37%

3-month gain/loss 9.61% 7.43% 3.10% 10.71% 4.52% 8.85% 5.79% 3.66% 7.43% 0.41% 2.07% 2.17% -1.88% -4.60% 0.16%

6-month gain loss 22.44% 12.28% 17.02% 20.01% 7.82% 14.15% 13.18% 8.13% 22.85% 11.26% 7.17% 13.70% 1.02% 7.68% 13.71%

52-week high 16,186.00 21,483.70 46,068.47 9,589.39 46,075.00 1,844.89 13,604.31 6,875.60 19,371.90 5,453.10 8,411.30 4,356.28 3,464.79 63,473.00 24,111.60

52-week low 10,374.80 17448.70 37,801.67 7,418.36 37,034.30 1,398.11 11,759.00 5,873.40 15,056.60 4,610.60 6,822.40 3,575.17 2,990.68 44,107.00 19,426.40

Previous 1 10 13 3 5 4 8 12 7 14 9 6 11 15 2

January 2014 CURRENCY TRADER

NON-U.S. DOLLAR FOREX CROSS RATES

Rank 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 Currency pair Franc / Yen Pound / Yen Pound / Aussie $ Euro / Yen Euro / Aussie $ Euro / Real New Zeal $ / Yen Franc / Canada $ Pound / Canada $ Canada $ / Yen Euro / Canada $ Canada $ / Real Aussie $ / Yen Aussie $ / Real Pound / Franc Yen / Real Euro / Pound Euro / Franc Aussie $ / Canada $ Aussie $ / New Zeal $ Aussie $ / Franc Symbol CHF/JPY GBP/JPY GBP/AUD EUR/JPY EUR/AUD EUR/BRL NZD/JPY CHF/CAD GBP/CAD CAD/JPY EUR/CAD CAD/BRL AUD/JPY AUD/BRL GBP/CHF JPY/BRL EUR/GBP EUR/CHF AUD/CAD AUD/NZD AUD/CHF Dec. 27 116.83 171.614 1.84322 143.28 1.538895 3.22599 85.49 1.18689 1.74348 98.435 1.455615 2.216235 93.105 2.096305 1.46895 0.022515 0.83488 1.22641 0.945885 1.08908 0.796945 1-month gain/loss 4.76% 4.61% 4.33% 4.29% 4.02% 4.00% 2.59% 2.44% 2.30% 2.26% 1.99% 1.98% 0.26% -0.01% -0.14% -0.29% -0.30% -0.44% -1.95% -2.26% -4.29% 3-month gain/loss 7.66% 8.22% 7.56% 7.41% 6.75% 7.10% 4.65% 4.73% 5.27% 2.80% 4.48% 2.51% 0.61% 0.33% 0.52% -0.29% -0.75% -0.24% -2.13% -3.86% -6.55% 6-month gain loss 12.41% 14.20% 11.19% 12.40% 9.44% 12.07% 12.63% 6.37% 8.06% 5.68% 6.36% 5.36% 2.70% 2.40% 1.59% -0.31% -1.57% -0.01% -2.81% -8.81% -8.63% 52-week high 116.83 171.614 1.8495 143.26 1.5456 3.2599 85.86 1.1981 1.7524 100.65 1.4632 2.3271 105.05 2.1995 1.4924 0.0248 0.8747 1.256 1.0685 1.2646 0.9942 52-week low 92.93 137.14 1.4439 112.21 1.2251 2.5251 69.75 1.0528 1.5286 85.69 1.2883 1.8879 87.02 1.9633 1.4062 0.0196 0.8106 1.2071 0.9224 1.0786 0.7892 Previous 8 2 1 9 6 7 4 16 11 5 17 3 15 14 10 12 18 13 20 21 19

GLOBAL CENTRAL BANK LENDING RATES

Country United States Japan Eurozone England Canada Switzerland Australia New Zealand Brazil Korea Taiwan India South Africa Interest rate Fed funds rate Overnight call rate Refi rate Repo rate Overnight rate 3-month Swiss Libor Cash rate Cash rate Selic rate Korea base rate Discount rate Repo rate Repurchase rate Rate 0-0.25 0-0.1 0.25 0.5 1 0-0.25 2.5 2.5 10 2.5 1.875 7.75 5 Last change 0.5 (Dec 08) 0-0.1 (Oct 10) 0.25 (Nov 13) 0.5 (Mar 09) 0.25 (Sep 10) 0.25 (Aug 11) 0.25 (Aug 13) 0.5 (Mar 11) 0.5 (Nov 13) 0.25 (May 13) 0.125 (Jun 11) 0.25 (Oct 13) 0.5 (Jul 12) June 2013 0-0.25 0-0.1 0.5 0.5 1 0-0.25 2.75 2.5 8 2.5 1.875 7.25 5 Dec. 2012 0-0.25 0-0.1 0.75 0.5 1 0-0.25 3 2.5 7.25 2.75 1.875 8 5
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CURRENCY TRADER January 2014

INTERNATIONAL MARKETS
GDP AMERICAS
Argentina Brazil Canada France Germany UK S. Africa Australia Hong Kong India Japan Singapore Argentina Brazil Canada France Germany UK Australia Hong Kong Japan Singapore

Period
Q3 Q3 Q3 Q3 Q3 Q3 Q3 Q3 Q3 Q3 Q3 Q3

Release date
12/20 12/3 11/29 12/24 12/14 12/20 11/26 12/4 11/15 11/29 11/14 11/22

Change
-6.7% -0.4% 0.9% -0.1% 0.5% 0.8% 1.5% 0.6% 6.3% 3.4% 0.4% 0.3%

1-year change
24.2% 10.6% 3.5% 0.1% 3.3% 1.9% 8.0% 2.3% 2.9% 12.0% 1.6% 6.3%

Next release
3/20 2/27 2/28 3/28 2/14 3/26 2/25 3/5 2/26 2/28 2/17 NLT 2/21

EUROPE AFRICA ASIA and S. PACIFIC

Unemployment AMERICAS

Period
Q3 Nov. Nov. Q3 Oct. Aug.-Oct. Nov. Sep.-Nov. Nov. Q3

Release date
11/18 12/19 12/6 12/11 11/28 12/18 12/12 12/17 12/27 10/31

Rate
6.8% 4.6% 6.9% 10.5% 5.0% 7.4% 5.8% 3.3% 4.0% 1.8%

Change
-0.4% -0.6% 0.0% 0.1% -0.1% -0.3% 0.1% -0.1% 0.0% -0.3%

1-year change
-0.8% -0.3% -0.3% 0.6% -0.2% -0.5% 0.4% 0.0% -0.2% -0.1%

Next release
2/19 1/30 1/10 3/6 1/7 1/22 1/16 1/20 1/31 1/29

EUROPE

ASIA and S. PACIFIC CPI

Period
Argentina Nov. Nov. Nov. Nov. Nov. Nov. Nov. Q3 Nov. Oct. Nov. Nov. Brazil Canada France Germany UK S. Africa Australia Hong Kong India Japan Singapore

Release date
12/13 12/6 12/20 12/12 12/11 12/17 12/11 10/23 12/23 10/31 12/27 12/23

Change
0.9% 0.5% 0.0% 0.0% 1.3% 0.1% 0.1% 1.2% 0.3% 1.3% 0.0% 0.7%

1-year change
10.5% 5.8% 0.9% 0.7% 0.2% 2.1% 5.3% 2.2% 4.3% 11.1% 1.5% 2.6%

Next release
1/15 1/10 1/24 1/14 1/16 1/14 1/22 1/22 1/21 12/31 1/31 1/23

AMERICAS

EUROPE AFRICA ASIA and S. PACIFIC

PPI AMERICAS EUROPE AFRICA ASIA and S. PACIFIC

Argentina Canada France Germany UK S. Africa Australia Hong Kong India Japan Singapore

Period
Nov. Oct. Nov. Nov. Nov. Nov. Q3 Q3 Nov. Nov. Nov.

Release date
12/13 11/28 12/20 12/20 12/17 12/12 11/1 12/12 12/16 12/11 12/27

Change
1.2% -0.3% 0.7% -0.1% -0.2% 0.2% 1.2% -2.6% 0.7% 0.1% -0.3%

1-year change
14.3% 0.8% -6.4% -0.8% 0.8% 5.8% 2.2% -5.2% 7.5% 2.7% 1.0%

Next release
1/15 1/6 1/31 1/20 1/14 1/30 1/31 3/13 1/16 1/16 12/27

As of Dec. 27 LEGEND: Change: Change from previous report release. NLT: No later than. Rate: Unemployment rate.

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January 2014 CURRENCY TRADER