november 2005 • strategies, news and analysis

8/14/2019 November 2005 Strategies, News and Analysis

1/57

November 2005 Strategies, News and Analysis for Forex Trader

Volume 2, No. 11

THE BEST TIMES TO TRADEdifferent currencies

EURO STRATEGYANALYSISreveals markettendencies

BARBARA ROCKEFELLERTechnicals duel

fundamentals

AUSSIE ANDKIWI DOLLARS:

Whats the play?

CURRENCY OUTLOOK FOR:Dollar/Canada,dollar/yen, Euro/dollar

FOREX EDUCATORS TURNED CTA MAKE THE GRADE

WALLWOOD CONSULTANTS


2/57

Contributors . . . . . . . . . . . . . . . . . . . . . 6

Letters . . . . . . . . . . . . . . . . . . . . . . . . . . 8

Industry NewsCongress, industry debate

CFTC authority . . . . . . . . . . . . . . . . . . 10While futures firms want to expand the

power of the Commodity Futures Trading

Commission to help fight fraud, others are

worried about giving the CFTC too much

clout.

Bernanke tabbed as new Fed head . . .11With Alan Greenspan set to retire in

January, President Bush selected

economist Ben Bernanke to be

Greenspans successor.

Forex Resources . . . . . . . . . . . . . . . . 11

Global Markets

The New Darling: Dollar/Canada . . . . .12Can Canada keep up its strength

into next year?

By Currency Trader Staff

Zero-interest rate policy weighs

on yen . . . . . . . . . . . . . . . . . . . . . . . . 14Will the yen fight back to its 2002

price levels?


Of Kangaroos and Kiwis:

The dollars down under . . . . . . . . . . .16Find out what the future has in store for

Australia and New Zealands economies

and currencies.

By Marc Chandler and Michael Woolfolk

Dollar depreciation likely to resume . .20The buck still faces challenges as theyear winds down.

By Tim Clayton

Big Picture

Fundamentals duel the technicals . . .24The market often processes news in

mysterious ways, but thats part of trading.

By Barbara Rockefeller

Currency Trader Interview

Wallwood Consultants practicewhat they preach . . . . . . . . . . . . . . . . . 30A look at how a two-man forex firm

successfully trades the forex market.


Currency Strategies

Price behavior in the Euro . . . . . . . . .34MFE/MAE analysis sheds light on the

Euro and how to trade it.

By Thom Hartle

CONTENTS

2 November 2005 CURRENCY TRADER

continued on p. 4


3/57
http://www.fxcm.com/


4/574 November 2005 CURRENCY TRADER

CONTENTS

Have a question about something youve seen inCurrency Trader?

Submit your editorial queries or comments to

[email protected].

Looking for an advertiser?Consult the list below and click on the company name for a direct link to the ad in this months

issue ofCurrency Trader.

Index of Advertisers

Currency Trader Q&A

Catching up with Richard Olsen . . . . .37A brief conversation with Olsen Group

founder Richard Olsen.By Currency Trader Staff

Currency Strategies

Trading around the clock, part I . . . . .38What are the best times to trade

different currency pairs?

By Kathy Lien

Currency System Analysis . . . . .42Dual timeframe stochastics.

Currency Futures . . . . . . . . . . . . . . .45News and trading statistics from the

currency futures world.

Currency Basics . . . . . . . . . . . . . . . . 46Comparing moving averages

A comparison of different types of

moving averages.

By Thom Hartle

Global Economic Calendar. . . . . . .50

Events . . . . . . . . . . . . . . . . . . . . . . . . . 51

International Market Summary . . .52

Global News Briefs . . . . . . . . . . . . .54

Forex Trade Journal . . . . . . . . . . . .55

Key Concepts and Definitions . . . .56

FXCM

Gain Capital

Vegas Expo

Forex Expo

Institute of Higher Earning

Paris Trading Expo
mailto:[email protected]:[email protected]


5/57

FOREX.com is a division of GAIN Capital Group a registered Futures Commission Merchant (NFA# 0339826), regulated by the Commodity Futures Trading

Commission (CFTC). FOREX.com is compensated for its service through the bid/ask spread. Forex trading carries a high level of risk and is not suitable for

all investors. Advanced GET Charts are available to clients who open an account with a minimum $2,500*.

Trade

Why are successful equity and futures tradersnow trading currencies?

Consider all the advantages of the worlds largest financial market:

Greater buying power control up to 200:1 leverage

No commissions or fees keep 100% of your trading profits

24-hour market trade on your schedule; respond to changesin the market immediately

Superior liquidity at $1.9 trillion per day, the sheer volumeof forex facilitates tighter spreads, with no slippage

Profit in both rising and falling markets no short selling restrictions

Register for a FOREX.com practice account and access a fully functional version of ourFOREXTrader platform, complete with streaming executable prices in 14 currency pairs,pro charting tools, real-time news, research, and more.

Test your strategies - risk freeTry a free 30-day practice account today

Youve Spent YearsTrading for This Moment.

Visit www.forex.comor call 1.877.FOREXGO

Exclusive OfferOpen an account and receive free access to eSignals Advanced GET Charts for Forex*
http://www.forex.com/linkc.html?src=ccytradermagNOV05http://www.forex.com/linkc.html?src=ccytradermagNOV05



Editor-in-chief: Mark Etzkorn

[email protected]

Managing editor: Molly Flynn

[email protected]

Associate editor: David Bukey

[email protected]

Contributing editors: Jeff Ponczak

[email protected],

Contributing writer: Carlise Peterson

Editorial assistant and

Webmaster: Kesha Green

[email protected]

Art director: Laura Coyle

[email protected]

President: Phil Dorman

[email protected]

Publisher,

Ad sales East Coast and Midwest:

Bob Dorman

[email protected]

Ad sales

West Coast and Southwest only:

Allison Ellis

[email protected]

Classified ad sales: Mark Seger

[email protected]

Volume 2, Issue 11. Currency Traderis published monthly by TechInfo, Inc.,150 S. Wacker Drive, Suite 880, Chicago, IL 60606. Copyright 2005TechInfo, Inc. All rights reserved. Information in this publication may not bestored or reproduced in any form without written permission from the publisher.

The information in Currency Tradermagazine is intended for educational pur-poses only. It is not meant to recommend, promote or in any way imply theeffectiveness of any trading system, strategy or approach. Traders are advisedto 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 notguarantee future results.

For all subscriber services:www.currencytradermag.com

A publication ofActive Trader

CONTRIBUTORSCONTRIBUTORS

Barbara Rockefeller (www.rts-forex.com) is an internationaleconomist with a focus on foreign exchange. She has worked as a fore-caster, trader, and consultant at Citibank and other financial institu-tions, and currently publishes two daily reports on foreign exchange.Rockefeller is the author ofTechnical Analysis for Dummies (2004), 24/7Trading Around the Clock, Around the World (John Wiley & Sons, 2000),The Global Trader (John Wiley & Sons, 2001), and How to InvestInternationally , published in Japan in 1999. A book tentatively titled

How to Trade FX is in the works.

Thom Hartle is a private trader and president ofMarket Analytics Inc. (www.thomhartle.com). In acareer spanning more than 20 years, Hartle has been acommodity account executive for Merrill Lynch, vicepresident of financial futures for Drexel BurnhamLambert, trader for the Federal Home Loan Bank ofSeattle, and editor for nine years ofTechnical Analysisof Stocks & Commodities magazine.

Marc Chandler is the head of global foreignexchange strategies at Brown Brothers Harriman and

an associate professor at New Yorks School ofContinuing and Professional Studies. From May 2001through Oct. 1, 2004, he was chief currency strategist atHSBC Bank USA. Prior to HSBC, he was the chief cur-rency strategist at Mellon Financial, a senior currencystrategist at Deutsche Bank, and the director of

research at EZA Associates.

Michael J. Woolfolk is senior currency strategist and vice presi-dent in the Global Markets Division at The Bank of New York. He isresponsible for North American currency research at the Bank of NewYork and is the chief architect and product manager for the highlyacclaimed interactive Portfolio Monitor (iPFM), which tracks the cross-border investment trends of the Banks $10 trillion custody business. Asthe sole press contact for the New York dealing room, he appears regu-larly on television and radio, and is frequently cited in the financialpress. Before joining the Bank of New York, he worked at Credit SuisseFirst Boston as a currency analyst in their London and New Yorkoffices. Woolfolk is currently an adjunct faculty member of New YorkUniversity and teaches a course on international political economics.

Jos Cruset ([email protected]) is a private trader, softwareengineer, and trading system researcher. He holds an MBA and aNASD-Series 3 certificate and has worked many years in the bankingindustry.

Kathy Lien is a chief strategist at FXCM, whereshe is responsible for research and analysis forDailyFX.com, including technical and fundamentalresearch reports, market commentaries, and tradingstrategies. She was an associate at JPMorgan Chase,where she worked for more than three years in creditderivatives, cross markets, and foreign exchange trad-ing. Liens experience encompasses trading both inand out of the forex market, including interest rate derivatives, bonds,equities, and futures. She has written for various industry publicationsand news outlets, including CBS MarketWatch, and she is frequentlyquoted on Bloomberg and Reuters. She is also author of the new bookDay Trading The Currency Market (John Wiley & Sons).
http://www.rts-forex.com/http://www.thomhartle.com/mailto:[email protected]:[email protected]://www.thomhartle.com/http://www.rts-forex.com/


7/57



LETTERS

The Euro FX trade shown in the September issuerefers to the September contract, but the chartshown is for continuous futures. Why? Is it better to

do ones analysis on continuous futures charts as opposedto spot forex charts?

Thank you for your suggestions.

Joseph

In this case, using the continuous futures chart was simply a mat-ter of convenience. Whenever the contract you are trading or ana-lyzing is the front month contract (the one closest to expira-tion), the continuous futures data will be the same as the front-month data. At the time this trade was entered (early August), theSeptember Euro FX contract was the front-month contract, whichmeans the prices on the continuous futureschart were identical to the September con-tract price.

For longer-term historical analysis orsystem testing, continuous futures are nec-essary because of the price jumps that occurfrom one contract month to the next. Also, you wont be able to reference historicalhighs and lows if you simply use the cur-rent front month. In terms of futures, its a good idea to look at both continuous andindividual contract month price data.

The major difference between spot forexdata and currency futures data (on a dailybasis) is the location of the closing price.

Spot forex prices dont have an official close because the tradingsession keeps moving to different market centers around the globe.In most cases, though, the New York session closing price is oftenused as the closing price on daily bars.

When it comes to actually buying and selling, its important to

reference the instrument youll be trading futures or spot. Youcan gain important insights analyzing both price series, however.The differences between spot and futures data is sometimes

misrepresented. The December issue ofCurrency Trader will fea-ture an article comparing spot forex and currency futures data.

Back issues and articles

Christian

IndividualCurrency Trader(andOptionsTrader ) articles are now available for

download through the Active Trader

store (www.activetradermag.com/pur-

chase_articles.htm).

Also, in the near future, we will be

offering compilations of back issues

on CD. Check our Web sites for

updates.

Spot vs. futures

Bob DormanAd sales East Coast and Midwest

[email protected]

(312) 775-5421

Allison EllisAd sales West Coast and Southwest

[email protected]

(626) 497-9195

Mark SegerAccount Executive

[email protected]

(312) 377-9435

Three good tools for targeting customers . . .

CONTACT

How do I acquire all of the past issues?
http://www.activetradermag.com/purchase_articles.htmhttp://www.activetradermag.com/purchase_articles.htmhttp://www.activetradermag.com/purchase_articles.htmmailto:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]://www.activetradermag.com/purchase_articles.htmhttp://www.activetradermag.com/purchase_articles.htm


9/57

November 19-20, 2005 Mandalay Bay Resort & Casino Las Vegas, Nevada

Attend the ONLY Expo Exclusively for Forex Traders

Keynote Address

Andrew Busch

Global FX StrategistBMO Nesbitt BurnsWhat to Expect From

Forex in the MonthsAhead: Using PoliticalTrends to GaugeCurrency Directions

Francesc RiverolaCEOFXStreet.comTrading SystemsCompared: A

ComprehensiveApproach

Steve Nison

Founder and PresidentCandlecharts.comCandlestick ChartingEssentials: Spotting theEarly Turning Signals inthe FX Markets

Rob Booker

Foreign CurrencyAdvisorRobBooker.comSmart MoneyManagement for ForexTraders

Platinum Sponsors

Gold Sponsors

EventSponsors

5 Reasons Why You Should Attend The Forex Trading Expo Education: conference sessions on topics ranging from trading systems to technicalanalysisinformation you can use immediately to make more profitable decisions

Networking: speak to other currency traders about what works for them and how they do it

Evaluate and Review: demo dozens of the latest trading tools and software systems

Technical Analysis: see first-hand what successful traders look for in forex charts,what indicators they use, and what time frames they use

Vision and Knowledge: hear from the best forex traders in the worldabout what they see in the short- and long-term currency markets

(You must purchase ticket to attend conference sessions: Prices are $249 before Sept. 30,$299 on or after Sept. 30; and $349 after Oct. 31. Admission to the Exhibit Hall is free.)

RegisterOnlinewww.ForexTradingExpo.com

Register Before Sept. 30 and Save $100 (priority code 005014)

Marketing Partner

The Premier Convention for Forex Traders

Media Partners

And Many More!
http://www.forextradingexpo.com/http://www.forextradingexpo.com/http://www.forextradingexpo.com/http://www.forextradingexpo.com/http://www.forextradingexpo.com/http://www.forextradingexpo.com/http://www.forextradingexpo.com/http://www.forextradingexpo.com/http://www.forextradingexpo.com/http://www.forextradingexpo.com/http://www.forextradingexpo.com/http://www.forextradingexpo.com/http://www.forextradingexpo.com/http://www.forextradingexpo.com/http://www.forextradingexpo.com/http://www.forextradingexpo.com/http://www.forextradingexpo.com/http://www.forextradingexpo.com/http://www.forextradingexpo.com/http://www.forextradingexpo.com/http://www.forextradingexpo.com/http://www.forextradingexpo.com/http://www.forextradingexpo.com/http://www.forextradingexpo.com/http://www.forextradingexpo.com/http://www.forextradingexpo.com/http://www.forextradingexpo.com/http://www.forextradingexpo.com/http://www.forextradingexpo.com/http://www.forextradingexpo.com/http://www.forextradingexpo.com/http://www.forextradingexpo.com/http://www.forextradingexpo.com/http://www.forextradingexpo.com/http://www.forextradingexpo.com/http://www.forextradingexpo.com/http://www.forextradingexpo.com/http://www.forextradingexpo.com/http://www.forextradingexpo.com/


10/57

INDUSTRY NEWS


The Commodity Futures Modernization Act,passed by Congress in 2000, gave the CommodityFutures Trading Commission the authority to reg-

ulate foreign currency futures and options contracts as longas they didnt fall under another jurisdiction.

However, the recent Zelener case, in which a court ruledthat spot forex transactions that called for delivery withintwo days were cash contracts and therefore not under thejurisdiction of the CFTC, even though the contracts wereoften rolled over like a typical futures contract and bought on margin, raised questions as to howmuch power the CFTC actually has (see Courtcase brings CFTCs authority into question,Currency Trader, May 2005).

As a result, the CFTC has asked for greaterpower in handling similar cases. A Senatecommittee wants to give it to them, in theform of the Commodity ExchangeReauthorization Act (CERA). The CERA,which is on the calendar for a full vote by theSenate, extends the CFTCs powers to cover situa-tions like those in the Zelener case.

Nonetheless, a debate rages as to just how muchpower the CFTC should have. While some believe anynew rule changes should affect only foreign exchange trans-actions, others think a variety of commodities should also

be covered.The Zelener case is not only about foreign exchange

products, says Charles Carey, chairman of the ChicagoBoard of Trade. The contract the Zelener Court found to beoutside the jurisdiction of the CFTC may just as easily beutilized by scammers to induce the unsuspecting to investin other commodities.

Such fraudulent operators could cause a scandal similarto those involving options on sugar and other commoditiesin the mid-70s. Such a scandal could, as then, reflectadversely on the legitimate financial services and deriva-tives industry in the U.S.

However, those who wish to limit the CFTCs authorityare concerned that new rules could give the Commissiontoo much power and distract it from its original mission.

The FIA disagrees with those who seek a broad fix,says John Damgard, president of the Futures IndustryAssociation (FIA). Expanding the CFTCs jurisdiction toapply to any form of non-futures contracts would have pro-found and, FIA believes, adverse implications for theCFTCs ability to discharge its oversight of futures andoptions exchange-trading, especially given the agencysstructure and limited resources.

Congress granted the CFTC exclusive jurisdiction over

the futures and related options markets in order to make

certain the CFTC would concentrate its efforts on those vitalareas of our economy.

Opponents of a broad fix fear that legitimate businesstransactions (e.g., the purchase of foreign currency at a cur-rency exchange, or transactions done by a bank or insur-ance company) would suddenly be under CFTC jurisdic-tion.

Nearly every prior [change in federal law] involvingthe scope of CFTC jurisdiction has caused significant

disputes or uncertainty with adverse consequences,says Marc Lackritz, president of the Securities

Industry Association. It is imperative thatCongress avoids legislative initiatives thatwill create these problems in new areas of

economic activity particularly where nocompelling public policy case has been pre-sented for enacting legislation that might

give rise to such risks.Chicago Mercantile Exchange chairman

Terry Duffy believes that addressing possibleviolations in other commodities only after multi-

ple cases of fraud have occurred is a case ofclosing the barn door after the horse has left.

Under the Zelener case, it does not matterwhat the dealer actually does or what the customer actual-ly expects, Duffy says. The sharp operators and bucket

shops have already figured out that the rationale of theZelener opinion can apply to commodities other than forex.How soon will it be before the CFTCs jurisdiction and itsretail consumer protections are reduced to irrelevance?

Duffy says the solution is a rule change that removes anyambiguity from the existing law that allowed the Zelenerdecision and applies to all commodity products, not justforex. Duffy and the CME have proposed legislation thatprovides for this without giving the CFTC power over spotforex or interbank transactions.

The trick is to protect retail customers without upsetting jurisdictional boundaries that were agreed to in the

CFMA, says Daniel Roth, president of the NationalFutures Association (NFA). Some have suggested that the best approach is to address Zelener only with respect toforex products. Forex is the current scam of choice amongfraudsters, but limiting a Zelener fix to forex ignores the his-tory of sales practice fraud and will not, in our view, reallyaddress the problem.

In NFAs 20 years of experience, we have seen that boil-er rooms really prefer to sell physical commodities thatretail customers deal with all the time. Sugar, gold, unlead-ed gasoline, heating oil these are the products that boilerrooms have historically favored. Foreign exchange rates, by

contrast, are fairly arcane.

Broad or narrow?

Congress, industry debate CFTC authority


11/57CURRENCY TRADER November 2005 11

With the imminent retirement of 18-year FederalReserve Chairman Alan Greenspan when histerm expires at the end of January, the unenvi-

able task of keeping the economy in check while makingsure his comments dont lead to a meltdown on Wall Streethas been given to Ben Bernanke.

Bernanke, the chairman of President Bushs Council ofEconomic Advisers, was appointed by Bush on Oct. 24 tofill Greenspans rather large shoes. A former Fed governor,Bernanke is well-liked and experts believe his confirmationprocess will be quick and easy.

The stock market agreed with the selection, as the Dow

Jones and S&P 500 had their biggest one-day increases since

April on the day Bernankes nomination was announced.Ben has done path-breaking work in the field of mone-

tary policy, taught advanced economics at some of our topuniversities, and served with distinction on the Feds Boardof Governors, Bush said at a press conference. Hesearned a reputation for intellectual rigor and integrity. Hecommands deep respect in the global financial communi-ty.

Bernanke said his first priority would be to maintain con-tinuity with the policies and strategies established duringthe Greenspan years.

Goodbye, Mr. Greenspan

Bernanke tabbed as new Fed head

FOREX RESOURCES

Inspired by the book The Wisdom of Crowds by James Surowiecki,

www.ConsensusView.com was launched to discover whether the idea

that the many are smarter than the few can give traders an edge in the financial

markets. The Web site allows participants in the stock, forex, and futures mar-

kets to forecast the direction of the markets and in return see the consensus view

of where a market is heading. Participation is free and there is $12,000 of prizemoney for the best forecasters, with an additional prize of $250 for the person

that referred them to the site. ConsensusView.com is the first Web site to open

the voting to all members of the trading community and to capture the consen-

sus on a daily basis. It keeps track of the hit rates of individual participants as

well as the hit rate of the consensus. Voting for all markets opens at 4:30 a.m.

London time and closes for each market as soon as it opens. Voters then get to

see the consensus view for that market. Furthermore, the site displays the top

five forecasters in each market as well as individual and consensus view hit

rates. The site covers the constituents of the S&P 500, the FTSE 100, and the top

70 stocks on the Toronto Stock Exchange. It also covers the 40 most actively trad-

ed futures markets as well as the 20 most actively traded forex currency pairs.

The EFX Group Williamsburgbranch is now offering hedge funds and

institutions their lowest available Tier 3 commission rate. Commissions are

based on the total dollar amount of currency traded each month; retail accounts

are initially charged $7 per $100,000 traded. At the end of each month, the total

dollar amount traded is calculated and a commission rebate is issued. Hedge

funds and institutions that open an account through the Williamsburg branch

will automatically receive their lowest rate of $5 per $100,000 traded, which is

normally only available after $70 million in currency is traded each month. For

more information on the three tiers and rates, visit

www.efxgroup.com/williamsburg.
http://www.consensusview.com/http://www.efxgroup.com/williamsburghttp://www.instituteofhigherearning.com/http://www.efxgroup.com/williamsburghttp://www.consensusview.com/


12/57

GLOBAL MARKETS


Despite a modest upside correction in the U.S.dollar/Canadian dollar rate (USD/CAD) intomid-October (Figure 1), the overriding long-term bear trend remains intact and currency

watchers expect renewed weakness in this pair into year-end.Since early 2002, the Canadian dollar has been in a strong

appreciation mode, and for now that long-term trend is inforce, analysts say. The USD/CAD has plunged from a

record-high $1.61 in January 2002 to the lowest levels inmore than a decade at $1.1586 in September 2005 (Figure 2).

It is the currency in vogue right now, says TimMazanec, senior FX strategist at Investor s Bank & Trust Co.

Commodity currency

Analysts say the massive appreciation in the Canadian dol-lar can in large part be attributed to the bullish cycle in com-modities. Canada, a large commodity producer andexporter, has benefited from the bull runs in the energy,lumber, and metals markets over the past several years.

The Bank of Canadas commodity index is up 25.7 per-

cent from last year, says David Powell, currency analyst atIdeaglobal.

The BOC has comprised a weighted index of the com-modities that Canada produces. The weights of some keycomponents are as follows: crude oil 21.40, lumber 13.58,and natural gas 10.69. Details on that index can be found at:www.bankofcanada.ca/en/rates/commod2.html.

A sharp rise in demand for energy products in recentyears has helped to bolster the Canadian economy and cur-rency. Charmaine Buskas, foreign exchange economist atEconomy.com, notes the Canadian energy export market is

actually skewed more toward natural gas than crude oil.Natural gas comprises 6 percent of the total Canadianexport basket, she says, vs. 5.6 percent of crude exports.Nonetheless, sharp rallies in both those energy productshave benefited the Canadian dollar.

Canadian natural gas exports comprised 16 percent ofU.S. natural gas consumption in 2004, Buskas says.

She adds that Canada exports more than one million bar-

rels per day of crude oil to the U.S. Canada is a small, butimportant energy exporter, given its proximity to the U.S.,she says.

Tightening phase

Another supportive factor to the Canadian currency (espe-cially the non-U.S. dollar cross rates) going forward is theresumption of an interest-rate tightening cycle by the BOC.

The BOC has begun raising rates in an attempt to slowthe economy and reign in burgeoning inflation. As hadbeen widely expected, the BOC pulled the trigger on a ratehike on Oct. 18, pushing the overnight rate 25 basis points

(bp) higher to 3 percent, the highest level in more than twoyears. That move was the second hike in 2005, after a 25-bphike in September.

Also, in its policy statement, the BOC said additional ratehikes would be needed over the next four to six quarters tokeep inflation on target. The central bank utilizes monetarypolicy to keep inflation near the midpoint of a 1- to 3-per-cent range.

Currency market participants recently honed in on thebanks comments that the Canadian economy appears tobe operating at its full production capacity.

Previously, the BOC had predicted that

wouldnt happen until the second half of 2006,Powell says. The output gap has now closed.While ahead of the October rate hike, most

analysts had expected the BOC to remain onhold at its next meeting on Dec. 6. Now ana-lysts say the forecasts have shifted. Most mar-ket watchers expect another 25-bp hike inDecember, which would bring the overnightrate to 3.25 percent by year-end.

Looking beyond that, Economy.comsBuskas expects another 50 bps of tightening in2006.

Commodities and favorable interest rates put the pluck in the Canadian buck.

The energy outlook looms large in the currencys future.

BY CURRENCY TRADERSTAFF

U.S. DOLLAR /CANADIAN DOLLAR AT A GLANCE

Average daily range (past 40 days) .0097

Average weekly range (past 26 weeks)

52-week high/low 1.2694 / 1.1630

U.S. CAN

Prevailing interest rates (%) 4.0 3.0

Next central bank meetings Dec. 13 Dec. 6

GDP Q3 2005* Q2 2005 Q1 2005

US CAN US CAN US CAN

3.8 3.2 3.3 2.7 3.8 3.2

All data as of Nov. 1 *Estimate

The New Darling: Dollar/Canada

.00222
http://www.bankofcanada.ca/en/rates/commod2.htmlhttp://www.bankofcanada.ca/en/rates/commod2.htmlhttp://www.bankofcanada.ca/en/rates/commod2.html



Narrowing interest-rate

differentials

The BOCs latest rate hike narrows theU.S.-Canada interest-rate differential. As ofNov. 1, the U.S. fed funds rate was at 4.00percent, in the wake of 12 consecutive ratehikes by the Federal Reserve.

Despite the narrowing, the interest ratedifferential is still in favor of the U.S, saysBob Lynch, head of G-10 FX strategy,America at HSBC. In fact, analysts sayDollar/Canada has trended lower in recentyears in spite of negative interest-rate dif-ferentials.

Nonetheless, the BOC and the Fed areraising rates at the same pace Mazanecsays both banks are expected to raise themat the next three meetings.

A look at the dataLynch believes the fundamental backdropis relatively positive for Canada because itruns a trade surplus and has the best fiscalposition within the G-7.

In 2004 Canadas gross domestic product(GDP) performance came in at 2.8 percent,vs. expectations for 2.7 percent this year.Into 2006, however, Mazanec says theCanadian economy may grow upwards of3.0-3.5 percent.

Economy.coms Buskas estimates third-

quarter GDP at 3.2 percent and fourth quar-ter at 3.1 percent.

On the inflation front, consumer pricesshot up 2 percent year-over-year in August,while core prices gained 1.7 percent.

On the crosses

There has been increased interest in tradingthe Canadian dollar on the crosses, accord-ing to HSBCs Lynch. Analysts say buyingthe Canadian dollar vs. the Euro, Swissfranc, and Japanese yen has been a favored

play, given Canadas positive interest-rate.It is the favorite currency for people to be longing right now, says IdeaglobalsPowell.

Key levels

Looking ahead, energy prices will be a key factor of addi-tional Canadian dollar strength. Analysts say if energy priceshold near current levels or strengthen, it will likely translateinto further Canadian dollar gains vs. the greenback.

Most analysts expect the USD/CAD to retest theSeptember low of $1.1586 before year-end. IdeaglobalsPowell saw potential toward the $1.14 area by year-end.

Mazanec reiterates a long-held market adage: You neverreally want to go against the trend, until the trend is bro-ken.

He points to the $1.1950 level as key resistance to watchon the upside for the USD/CAD.

A close above that level might give us a signal that a lowis in, he concludes. Conversely, a push back under $1.1650and traders would start looking for $1.1200.

Despite the bounce this month, the long-term downtrend reflecting the

Canadian dollars strength is still intact.

FIGURE 1 U.S. DOLLAR/CANADIAN DOLLAR, DAILY

Source: TradeStation

After making record highs in 2002, the USD/CAD made new lows in September2005.

FIGURE 2 U.S. DOLLAR/CANADIAN DOLLAR, MONTHLY




GLOBAL ECONOMYcontinued

After three years of bearishaction, U.S. dollar/Japaneseyen (USD/JPY) bulls havecontrolled the market for

much of 2005 (Figure 1). And with bullish

interest rate differentials strongly favoringthe U.S. dollar, most currency watchersexpect the uptrend in dollar/yen to contin-ue into year-end.

Dollar/yen tested major long-term sup-port at the 101.50 area in January 2005and that floor proved to be a solidlaunching pad for months of steadygains in the pair. Since that Januarylow, dollar/yen bulls have propelledthe pair toward the 116 level as of lateOctober (Figure 2).

Plain and simple, bullish interestrate differentials in the U.S. dollarsfavor have been a major factor pro-pelling dollar/yen higher for much ofthis year. As of Nov. 1, the U.S. Fedfunds rate stands at 4 percent vs. theBank of Japans zero-interest rate poli-cy.

Searching for yield

Analysts point to an outflow ofdomestic Japanese money as a factor

weighing on the yen, as investorsthere chase higher yields elsewhere.Japanese individuals are fed up

with zero interest on bank deposits,says Masaaki Kanno, managing direc-tor at JP Morgan in Toyko.

Japanese investors are understand-ably attracted to much higher yieldsavailable offshore, says Sean Callow, senior currencystrategist at Westpac Institutional Bank in Singapore. Forinstance, U.S. two-year Treasury bonds offer almost 4 basispoints of pick-up over two-year Japanese government bonds, while New Zealand offers a huge 5.90 extra basis

points. Japanese demand for bonds such as New Zealandshas been very robust not just from institutions, but alsofrom retail, individual investors.

In recent weeks, speculators have jumped on thedollar/yen bull trend bandwagon as well. Callow noted that

Dollar/yen bulls have been in control since the market bottomed at the

beginning of this year.

FIGURE 1 DOLLAR/YEN, MONTHLY


Zero-interest rate policy weighs on yenJapans stronger economic performance would seem to be good news for the yen, but the countrys

sustained zero-interest rate policy is keeping the pressure on.

U.S. DOLLAR/JAPANESE YEN AT A GLANCE

Average daily range (past 40 days) .84

Average weekly range (past 26 weeks) 1.89

52-week high/low 115.99 / 101.68

U.S. JP

Prevailing interest rates (%) 4.00 0

Next central bank/

monetary meetings Dec. 13 Nov. 18GDP Q3 2005* Q2 2005 Q1 2005

U.S. JP U.S. JP U.S. JP

3.8 0.4 3.3 3.3 3.8 5.8

All data as of Nov. 1 *Estimate




the recent Committment of Tradersdata, released by the CFTC, revealedthat large speculators had built up theirhighest long dollar/yen futures posi-tions since 1999.

Higher levels for dollar/yen

Several market watchers saw potentialfor the dollar/yen to continue its rallyinto year-end. JP Morgans Kanno tar-geted gains in dollar/yen by the end ofDecember at 118 and as high as 120 byMarch 2006.

As long as the Fed continues tohike the Fed funds rate in Novemberand December, widened interest ratedifferentials will induce further capitaloutflow from Japan, Kanno says.

Tim Mazanec, senior foreign

exchange strategist at Investors Bank& Trust, noted that the 115 level is sig-nificant on a longer-term basis for thedollar/yen. As of late October, it hadpushed above that key level, climbingas high as 115.99.

The 115 level has been critical over the past four years asboth support and resistance, he says. If we can stay aboveit, that would be extremely bullish and we could see gainstoward the 122 area over the next six to 12 months.

In the Oct. 21 issue ofThe Global Economy This Week, ana-lysts at Credit Suisse First Boston bumped up their three-

month dollar/yen forecast to 117.We have moved toward a more yen-negative forecast

near term as Japanese investors unhedge existing stocks ofhedged foreign assets, overshadowing foreign inflow toequities, CSFB analysts wrote.

Brighter economic prospects ahead

Despite calls for further weakening in the Japanese curren-cy vs. the dollar, economists say Japans overall fundamen-tal outlook is improving.

We are optimistic about Japans recovery, seeing agrowth of at least trend in 2005 at 2.0%, says Westpacs

Callow.Job creation is expected to continue, with expectations forthe overall unemployment rate to fall to 3.8 percent in 2006from an expected 4.3 percent in 2005.

The September general election win by Prime Minister Junichiro Koizumi was seen as a bullish factor for theJapanese economy, as a major goal of Koizumis is privati-zation of the Japanese postal system (which also includesthe nations largest bank), which is seen as constructive forlonger-term growth there.

End of zero-interest rate policy in sight?

The BOJs most recent assessment of the economy was

more upbeat than we had expected, which tends to suggestthe bank may indeed be taking some cautious steps forwardin terms of preparing markets for a policy shift, says Dr.Matthew Cairns, senior economist at Economy.com.

Cairns noted that the BOJ has outlined three conditions thatwill need to be met for the bank to shift its current policy.

Core consumer prices must stop falling at least for a few

months, and board members must be sure that prices wontresume their fall, he says. Also, the bank must be confi-dent about the overall strength of the economy.

JP Morgans Kanno believes that a 0.25-percent rate hikecould occur in the second half of 2006.

However, other market watchers believe the end of thezero-interest rate policy could take even longer. In thefourth quarter 2005 Global Forex Outlook report, analysts atIdeaglobal wrote, we do not look for an ending of ZIRP[zero-interest rate policy] during the 12-month forecasthorizon and feel that an actual hike can occur in the periodof November 2006-May 2007.

MOF back in play?

For now, the Ministry of Finance has been on the sidelinesin terms of dollar/yen action. But if the recent rally contin-ues, some say the MOF may step back into play.

There is some likelihood that the Ministry of Financewill make a dollar selling intervention if dollar/yen goesabove 120, Kanno says.

While analysts generally contend central banks have adifficult time changing a long, strong trend in the foreignexchange market, shorter-term currency traders need tostay on their toes around major price levels, which couldpotentially draw in central bank intervention.

September and October were especially strong months for the currency pair,which had peaked just shy of 116 as of Oct. 25.

FIGURE 2 DOLLAR/YEN, DAILY




The Australian and NewZealand dollars areinteresting currencies forspeculators, investors,

and economists, but are not regardedas major currencies. Their liquidity hastraditionally been concentrated in thelocal markets, but over the past coupleof years interest has grown globally, fora number of reasons (Figure 1).

From an economic point of view,one of the most interesting things dis-

tinguishing the antipodean currenciesfrom the Canadian dollar, with whichthey often get lumped together, is thatboth Australia and New Zealand havesignificant current account deficits.

According to an Economist magazinesurvey, Australias current accountdeficit is expected to be almost 6 per-cent this year and a still-wide 5.5 per-cent next year. New Zealands tradedeficit is on pace this year to reachnearly 8 percent of GDP, and any improvement next year is

likely to be marginal.Both the Australian and New Zealand dollars have lostground against the U.S. dollar this year (Figure 2). But theirless than 3-percent declines mean that on a relative basisthey have outperformed currencies from countries withsizeable current account surpluses, such as Switzerland and

Japan. The Swiss franc has declined about 11 percent

against the U.S. dollar from January through late Octoberthis year and the Japanese yen has depreciated about 11.5percent over the same period.

In fact, one popular trade this year among some specula-tive players and Japanese investors has been buying theAustralian and/or New Zealand dollars against the Japanese

GLOBAL MARKETS

Favorable interest-rate differentials and a positive outlook for commodities have

fueled both the Aussie and Kiwi dollars in recent years.

FIGURE 1 AUSSIE DOLLAR


Of Kangaroos and Kiwis:The dollars down under

The past few years have been good

to the Aussie and Kiwi dollars, but

uncertainties over global commodity

demand and interest-rate shifts could alter

the landscape for these currencies.

BY MARC CHANDLER AND MICHAEL WOOLFOLK

A popular trade this year among some speculative players and Japanese

investors has been buying the Australian and/or New Zealand dollars against

the Japanese yen.



yen (Figure 3). In early October, the New Zealand dollarreached an eight-year peak against the yen and theAustralian dollar recorded a seven-year high against the yen.

Forex speculators have been drawn to the trade in part toexpress a favorable view of commodities. Australia, forexample, is the worlds fourth largest producer of copper,

and copper prices have rallied sharply to new all-timehighs. Some traders also emphasize the role of Australia asa producer of gold, which recently reached 17-year highs.

Interest rate differentials:

Advantage New Zealand?

Market players have also been attracted to the relatively highyields offered by Australia and New Zealand. Their key rates,comparable to the U.S. Fed Funds rate,stand at 5.5 percent and 6.75 percent,respectively. Official interest rates inAustralia have been on hold since they

were last raised in March. In contrast,New Zealand hiked its official rate to 7percent on Oct. 27, the eighth hike sincethe beginning of last year. Another hikein December is also possible.

Although the yield pick up for theU.S. (3.75 percent Fed Funds rate,which will likely rise to 4.25 percent byyear-end) and European investors (2.0percent key rate, with the ECB likelyon hold for at least several months), issubstantial, it is even more significant

for Japanese investors, whereovernight interest rates remain close tozero and 10-year bond yields arearound 1.45 percent. Australias 10-year bond yields are around 5.35 per-cent and New Zealands 10-year bondyields are just below 6 percent.

A number of corporations, includingGermanys agriculture and forestryfinancial corporation Rentenbank,

supranational agencies such as the World Bank, and sover-eigns such as the Province of Ontario, have offered NewZealand dollar-denominated bonds in Japan aimed at retailinvestors.

Reports suggest Japanese retail investors have shiftedtheir preference from Australian fixed-income instrumentsto New Zealand denominated issues. At a little less thanNZD $20 billion, the issuance of these bonds, called uri-dashi and eurokiwi, are running at nearly twice as

much as last years levels and appear to be an importantsource of demand for the New Zealand dollar.

Economic analysis

The New Zealand economy appears to be on somewhatmore solid footing than Australias. At 1.1 percent, Q2

growth was stronger than consensus expectations. Thewidening current account deficit appears to reflect robustdomestic demand. Building approvals, while still below lastyears levels, rose 6.8 percent in August to a five-monthhigh.

The Australian economy is more fragile. Housing andconsumer spending, previously important growth engines,are slowing, without new leadership emerging. Some

hoped exports would assume the mantle, but these fellabout 3 percent in August to a five-month low. Commodityexports, which account for about 10 percent of AustraliasGDP, have weakened, especially foodstuffs and fibers. Forexample, the export of wheat and other cereals are off 38percent year-over-year and world exports have fallen by 14percent in the July-August period.

Unlike New Zealand, Australia also recorded a decline incontinued on p. 18

The Australian and New Zealand currencies have lost ground to the U.S. dollar

this year, but not as much as many other currencies. Looking forward, the New

Zealand dollar may be better positioned than the Aussie dollar.

FIGURE 2 KIWI DOLLAR


The New Zealand dollar is better positioned to hold its own. Its central bank is one

of the few that can keep pace with the Feds tightening in the coming months.



imports, suggesting domestic demand is soft. Some meas-ures of consumer confidence stand at two-year lows despitea fairly tight labor market. Unemployment in Australiastands at 5 percent, down from 5.7 percent a year ago.Rising gasoline prices and a softer housing market appear

to have taken their toll.Profit-taking on commodity and energy companies, fears

the U.S. economy may be slowing, and a sell-off in global

equity markets triggered a sharp sell-off in Australianstocks recently. The S&P/ASX 200 Index dropped 4.3 per-cent on Oct. 5 and 6, the largest two-day decline sinceSeptember 2001, when the terrorist attack on New York Citytriggered a 4.7-percent decline. The sell-off has come fromlofty levels as the index made its record high on Sept. 29.

Australias GDP is about $400 billion, while New Zealandsis around $59 billion. Australia is New Zealands largest trad-ing partner, absorbing about a fifth of its exports and account-ing for about a quarter of its imports. Given the size consider-ations and economic integration of New Zealand withAustralia, many equity investors take a combined view oftheir currencies, although playing the Aussie/Kiwi cross is

common in the foreign exchange market.There is an exchange traded fund for Australian stocks the

MSCI Australian index (EWA). Even with the sharp decline inAustralian shares in recent days, it is still up more than 10 per-cent on the year and about 41 percent year-over-year.

A popular way to play Australias commodity exposureis through BHP (symbol BHP), the worlds largest miningcompany. It trades as an ADR and is up about 31.5 percent

year-to-date and up almost 48 percentyear-over-year. Another Australiancompany, Rinker (RIN), has attractedmuch interest as a way to get someAustralian market exposure as well asplay the U.S. construction sector(housing and reconstruction). Rinker isthe biggest supplier of cement blocksin the U.S. It is up about 88 percent

over last year and about 43 percentyear-to-date.

Currency outlooks

The near-term outlook for theAustralian dollar is favorable, especial-ly if the U.S. dollar corrects from its broad September/October rally.However, unless the economic dataconvinces the market a Reserve Bank ofAustralia (RBA) hike is likely in thefirst quarter of 2006, the AUD can buck

the generally firm tone for the U.S. dol-lar. In a strong U.S. dollar environment,the Australian dollar may generallyfare even better than the Swiss franc,Euro, or yen.

The New Zealand dollar is betterpositioned to hold its own. Its central bank is one of the fewthat can keep pace with the Feds tightening in the comingmonths, which may help the Kiwi hold up on a cross basisas well. The NZD could rise into the $0.7100-0.7150 area,which capped during the summer, from its current $0.6960area. That said, an advance above $0.7100 would violate a

six-month downtrend and could trigger a stronger move.

Balancing acts

Australia and New Zealand both suffer from structural cur-rent account imbalances owing partly to their geographicalisolation. Despite being important commodity exporters,both economies are highly developed and driven by con-

GLOBAL ECONOMYcontinued

In 2005, some traders and Japanese investors have been buying the Australian

(or New Zealand) dollar against the Japanese yen.

FIGURE 3 AUSSIE DOLLAR/YEN


Interest rates in New Zealand and Australia typically offer a 100-200 basis point

premium over rates in countries with similar risk and inflation.



sumer spending. Given the relative wealth of Aussie andKiwi consumers and the largely commodity-based natureof the local economies, many consumer goods are importedfrom the U.S., Europe, Japan, and Emerging Asia. In con-trast to other developed nations, Australia and New

Zealands structural trade deficits are inflexible to foreignexchange rates because of this lack of domestic productionof substitute consumer goods.

Australias current account has been in deficit for more

than 40 years, and has varied between -2 to -7 percent ofGDP over the past twenty years. This measure cycles every

four to five years with changes in the economy and value ofthe currency.

New Zealands current account deficit is less well-behaved owing to the economys high degree of geograph-ic isolation and dependence on imported goods. Over thepast 15 years it has varied from -3 to -8 percent of GDP.Concerns have emerged recently over both the pace of thecurrent account deterioration as well as the level.

In both instances, structural current account imbalancesare financed by structural net inflows of both direct andportfolio investment. One reason for this is interest rates inNew Zealand and Australia typically offer a 100-200 basis

point premium over rates in countries with similar risk andinflation. This interest rate premium attracts foreign invest-ment into deposits and fixed income instruments that serveto finance the structural current account imbalances in bothcountries.

The two factors that have a material impact on this bal-ance and therefore on the value of the local currencies are growth and interest-rate differentials. As interest ratedifferentials rise, there is an increased attraction for localdeposits and fixed income instruments. The AUD/USD andNZD/USD rates thus tend to rise as interest rate differen-tials rise. A countervailing factor is the pace of economic

growth. As the economy accelerates, the current accountdeteriorates. Unless interest-rate differentials correspond-ingly widen, the local currency comes under pressure.

This is in fact what happened during 1996 to 2001.Economic growth was strong while interest-rate differen-tials were narrow. AUD/USD fell below 0.50 in 2001 from0.80 in 1996. Similarly, NZD/USD fell to 0.40 from 0.70 in1996. The depreciation in the NZD was so severe that bylate 2000, the AUD/NZD cross-rate had risen to 1.30. Thisprompted calls in some quarters for a currency unionbetween the AUD and NZD. Steady improvement in theAUD/NZD cross-rate to 1.10 by 2002 buried such talk.Nonetheless, this demonstrated how growth and interest-

rate differentials can impact antipodean currency valua-tion.

Searching the horizon

Looking forward, the long-term outlook is not favorable

for the antipodean currencies. Tighter monetary and fiscalpolicies globally are likely to slow global demand forAussie and Kiwi commodity exports as well as lower com-modity prices in general. With current account imbalances

unlikely to correct significantly over the next several years,the expected compression in interest-rate differentials will

undermine the value of the AUD and NZD on reduceddemand for locally denominated deposits and bonds.Given the regional popularity of AUD/JPY and NZD/JPYcarry trades, monetary tightening in Japan may have astrong negative impact on antipodean currency value. TheBank of Japan will eventually end their zero interest ratepolicy (ZIRP) and begin lifting rates as soon as Q2 2006.

Another factor likely to weigh heavily upon interest-ratedifferentials and local currencies is housing prices. Muchlike circumstances in the U.S. and UK, real estate prices inurban and vacation areas have soared over the past fiveyears. The housing market and the risk of a downward

destabilizing correction appears to be a policy considerationat the respective central banks.The problem is most pronounced in Australia, although

New Zealand and Australian interest rates tend to be posi-tively correlated. While new home sales and real estate con-tinue to rise, the RBA will be reluctant to cut interest ratesdespite tepid consumer price inflation. Once the real estatesector begins to cool, the RBA will have greater policy flex-ibility and could begin cutting rates.

Whereas the near-term outlook is positive for theantipodeans, the longer-term outlook looks increasinglynegative, dependent upon the compression of interest-rate

differentials over the next two years and the extent of theimpending slowdown in global growth.Of particular note is the variable outlook of the AUD and

NZD against the majors. The much-anticipated decline ofthe USD against emerging Asian currencies in general andthe Chinese yuan (CNY) in particular has yet to materialize.Its assumed China will continue to intervene to keep cur-rency appreciation in check. If it curtails its currency inter-vention, the AUD and NZD might find another source ofsupport.

For information on the author see p. 6.Questions or comments? Click here.

Tighter monetary and fiscal policies globally are likely to slow global demand for

Aussie and Kiwi commodity exports as well as lower commodity prices in general.
mailto:[email protected]?subject=Chandlermailto:[email protected]?subject=Chandler



Yield factors will remain very important inthe short term, and confidence in furtherU.S. interest rate hikes will offer dollar sup-port, especially as the higher yield structure

will discourage speculative selling.The market has, however, already factored in further rate

increases, which will make it more difficult for the U.S. cur-rency to secure fresh buying inter-est. Also, growth will likely falter

as consumer spending comesunder pressure; this would triggera significant deterioration in dol-lar sentiment as markets wouldanticipate a peak in U.S. interestrates.

Although the dollars structuralweaknesses tended to be of sec-ondary importance over the pasttwo quarters, they certainlyshould not be ignored. The highU.S. current account deficit will

sustain the risk that dollar confidence will crumble, whileunderlying central bank reserve diversification away fromthe U.S. currency will continue. (For an in-depth look atcentral bank diversification, read Foreign exchangereserves the who, what, and why, in the January 2006issue ofActive Trader magazine, which will be available inDecember.)

In the short term, market forces are likely to be near bal-ance, limiting dollar moves, with a 1.1870-1.22 range in theEuro/dollar rate realistic (Figure 1), and the Euro likely togain support from a tough European Central Bank (ECB)stance and potential rate increase this quarter. Once the cap-ital repatriation flows stop toward the end of 2005, the dol-

lar will be much more vulnerable to any shortfall in capitalinflows, and this could be decisive in pushing the U.S. dol-lar lower. Late in the fourth quarter, dollar losses toward1.25 are likely.

Dollar takes advantage of yield support

The dollar has continued to draw strength from yield con-siderations over the past fewweeks, with a short-lived push to

the 2005 EUR/USD low of 1.1870in October.

Inflation and interest rate con-siderations will tend to dominatein the short term, especially withthe jump in reported U.S. inflation.Consumer prices rose 1.2 percentin September, with the annualinflation rate pushing to a 15-yearhigh of 4.9 percent.

Core inflation indicators haveremained under control; the

underlying consumer price index increase (CPI) held at 0.1percent for September. The annual increase fell to 2 percentfrom 2.2 percent and the Federal Reserves preferred meas-ures of inflation have held below 2 percent over the pastfew months. The central bank still fears the jump in energyand raw material costs will gradually feed wider inflation-ary pressures over the next few months.

The Federal Reserve has increased interest rates at its past11 meetings and there is a strong probability it will tightenagain at the beginning of November. Futures markets havepriced in at least one further increase after that and there areexpectations short-term rates will increase to 5 percent overthe course of 2006, compared with current Euro levels of 2

GLOBAL MARKETS

Dollar depreciation

likely to resumeThe near-term outlook is relatively stable, but major market forces could be lining up to exert more

pressure on the dollar as time passes.

BY TIM CLAYTON



percent. Ten-year T-note yield spreads over German bundshave also increased to levels last seen in 1999, but the

Federal Reserve will need to anchor inflation expectationsto sustain attractive real yields.

Growth doubts likely to increase

The Fed, however, has a dual mandate of maintaining pricestability and the highest possible level of employment. It

will, therefore, be placed in a very difficult situation if thereis a rise in inflation at the same time as a deteriorating econ-omy.

The U.S. labor market remained strong in the third quar-ter and the unemployment level remained low at 5.1 per-cent. There is still likely to be unease over the sustainabilityof consumer spending, especially as the savings rate isalready at a very low level. In this environment, any nega-tive income shock will quickly result in lower spendinggrowth.

Retail sales rose 0.2 percent in

September, a 1.1-percent increaseexcluding auto sales, but spendingwas inflated by the sharp rise in gaso-line prices. Consumer confidence lev-els have continued to deteriorate, withlittle evidence of a recovery from thehurricane Katrina shock. Althoughconfidence levels do not have a strongpredictive track record for consumerspending trends, there will still be con-cern over underlying conditions, espe-cially if high energy prices are sus-

tained or employment growth slows.In this context, the housing sectorwill remain very important for the U.S.economy and the currency. If priceshold firm there will be a much-reduced risk of a drop in consumerspending. Conversely, any significantdrop in prices would increase thethreat to consumer spending. Overall,the risks to retail demand will increase,especially as rising long-term interestrates will push up mortgage rates.There are, therefore, likely to be con-

straints on Fed tightening starting in early 2006.

Important change at the FedAdditional uncertainty over Fed policy is likely to be creat-ed early in 2006 when Chairman Alan Greenspans term inoffice comes to an end after 18 years. Ben Bernanke, head ofthe Council of Economic Advisors, has been nominated tosucceed Greenspan and has pledged policy continuity. (see

Bernanke tabbed as new Fed head). The new chairman islikely to be slightly more cautious in the short term, espe-cially given his previous unease over deflationary trends inthe economy, which could deter further rate increases. It ispossible the rate-hike cycle will peak at the end of 2005,making the dollar vulnerable going forward.

Interest rate levels will still offer some support even if theFed halts the tightening process. With U.S. rates at 1 per-cent, the dollar was vulnerable to selling pressure during

continued on p. 22

The Euro lost ground vs. the dollar in September, but there is evidence thebucks strength will not last, given the challenges it faces in the coming year.

FIGURE 1 EURO/DOLLAR, DAILY


It is possible the U.S. rate-hike cycle will peak at the end of 2005,

making the dollar vulnerable going forward.



2003 and 2004 there was a strongincentive for investors to use the dollaras a global funding currency andinvest in high-yield securities. Higher

U.S. interest rates have discourageddollar selling, and there has been agreater temptation to use currenciessuch as the Euro and yen as fundingvehicles. Given the rise in short-termyields, the dollar will, therefore, be lessvulnerable to selling pressure, but itwill still be vital to sustain confidencein the U.S. economy.

Dont forget trade

The underlying U.S. trade deficit has

shown some signs of stabilization, butthe position is still precarious, with adeficit of $59 billion for August.

Initially, the deficit will continue tobe inflated by high oil imports, and theU.S. current account deficit is liable to be at least 6.5 percentof GDP for 2005. The U.S. has, so far, avoided payment dif-ficulties, but a deficit at this level is unlikely to be sustain-able in the medium term.

Chinas trade surplus with the U.S. has continued to rise,with a $22 billion shortfall reported for August, as importsfrom China continued to increase rapidly. There will be the

risk of escalating trade tensions if the U.S. deficit continuesto increase, with political pressure for stronger Asian cur-rencies. These tensions would also increase the risk of widerselling pressure on the dollar.

There hasnt been any official intervention in the curren-cy markets over the past few months. The European andAsian central banks are, however, likely to discourage fur-ther strong dollar gains, especially as a weaker or at least acompetitive dollar will be seen as an important element innarrowing global trade imbalances. Some dollar selling isalso likely to be seen as an important element of medium-term central bank reserve management.

Capital flows vital

The capital account trends will remain important for theU.S. currency. The Homeland Investment Act (which tem-porarily removes the disincentive for U.S. businesses tokeep offshore profits offshore for tax purposes) will contin-ue to provide tax breaks for capital repatriation back to theU.S. until the end of 2005. The lower tax rate will encouragea flow of funds back to the U.S. during the fourth quarterand offer important balance of payments support.

There is, however, likely to be underlying reserve diver-sification away from the U.S. currency and, with directinvestment flows still weak, the dollar will be more

dependent on short-term capital inflows to avoid deprecia-tion. The most recent capital flows data has been encourag-ing, with net inflows of $91.3 billion for August supportedby strong flows into U.S. bonds. Inflows at this level wouldalleviate short-term financing concerns and underpin thedollar. The overall risks are, however, likely to be asymmet-rical given the wide current account deficit and likely drop

in official inflows.

ECB on alert

The Euro-zone growth prospects will remain subdued inthe near term, but there is some evidence of a Germanrevival and the economy is also gaining support from theweaker Euro. Overall growth rates will remain uninspiringat best.

The Euro-zone consumer inflation rate increased to arevised 2.6 percent in September from 2.5 percent and theECB will be concerned over the inflation outlook, especial-ly as inflation is above the 2-percent target. Although the

underlying inflation rate is under control, the bank will beon high alert and anxious to avoid secondary inflation fromtaking hold.

The ECB will continue to face a tough balancing act in theshort term as it would prefer to avoid higher interest ratesgiven the fragile state of demand. The ECB will, however,need to control inflation expectations, especially with risingmoney supply growth. It will consider a rate increase in thefourth quarter and will continue the tough rhetoric even ifrates are left at 2 percent. A tighter ECB stance would offersupport to the Euro.

For information on the author see p. 6.

GLOBAL MARKETScontinued

Interest rate differentials have shifted in favor of the dollar since 2004. While the

ECB repo rate has remained steady, the U.S. Fed funds rate had increased to 4percent by Nov. 1.

FIGURE 2 THE INTEREST RATE PICTURE


23/57
http://www.salonat.com/



We like to say that a really juicy piece offundamental information will trump thetechnicals every time. Technicals are thequantification of what traders think and

believe, and what they think and believe is shaped by thefundamentals. Fundamentals include economic news, insti-tutional arrangements, business conditions, and the occa-sional dash of politics.

But is it really true that fundamentals trump technicals?

The forex market has become so enamored of technicalanalysis that today we have to question whether the funda-mentals actually do rule the market. Sometimes it seemstraders are perverse in their response to real events, inter-preting them to suit the chart instead of adjusting the chartto reflect economic reality.

Lets look at a few cases from the past few months and tryto name a winner.

Three types of fundamental events

The fundamentals are real economic data, developmentsin related markets, and institutional changes, such as cen-

tral bank policy decisions. Very little of what passes fornews is actually new. In nearly every case, we know thenews is coming usually to the exact minute and wealso know the likely range of the data or the expected con-tent of the announcement.

It is a triumph of the electronic age that we have so muchinformation and can usually slot it into context, to boot.Newspapers and newswires tell us, for example, the currentquarterly GDP growth rate vs. the previous quarter, theannualized rate, the last time it was so high or low, how itcompares to the growth rate for the same period in othercountries, and so on. Traders in the foreign exchange mar-ket keep track of about a dozen of these factors and gird

themselves for action if the news varies significantly fromthe consensus forecast.

News encompasses three types of events. The first is eco-nomic data and developments, which rotate in importanceover time. Sometimes trade balance is important, some-times its not. For the past few years as we have all puzzledover the jobless recovery, the U.S. non-farm payrolls reporthas been a zinger, causing one-day price spikes, sometimesin both directions on the same day. The short list of news

items that move the forex market includes:

GDP Inflation (various forms PPI, CPI, PCE, GDP

deflator, ECI) Trade balance and current account balance Capital flow reports Payrolls Institute of Supply Management (ISM) Index and

regional indices (Chicago, Empire State) Leading indicators, business confidence, and

consumer confidence

University of Michigan consumer confidence Durable goods orders Housing starts and existing home sales Retail sales

Notice that money supply growth, bank lending, andother financial sector information is not of much interesttoday for evaluating the U.S. economy and the dollar,although it was the only thing traders looked at in the early80s (it is still watched today in Europe and Japan).

Truthfully, traders are bored by this type of news. Theyrespond to it in the expected ways buying, grudgingly, ifa number surpasses the upper limit of an estimated range.

THE BIG PICTURE

Fundamentals duelthe technicalsFundamentals may rule the den in the long run, but short-term reactions

in the market are often based on anything but rational analysis.

BY BARBARA ROCKEFELLER


25/57



numbers and this was an especially easy one to spot. Thebounce up off the retracement line was facing a heavy head-wind in the form of talk about upcoming interest-rateincreases in the U.S., so traders needed a better-than-usual

excuse to keep the move going. Hurricane Katrina fit thebill nicely and had the added benefit (for dollar shorts) ofcreating the spectacle of the worlds richest country failingto provide timely and adequate relief to its own citizens.The can-do country couldnt. This is an instance where thegiant miasma of anti-U.S. sentiment that hangs over the dol-lar took concrete form.

It quickly became clear, however, that the hurricanewould take away only 0.5 to 1 percent of GDP in the near-term and actually add to GDP in later quarters as re-building began. Germany, the Eurozones biggest economy,

will get 0.8-1.2 percent growth this year. A natural disaster

that removed 0.5-1 percent ofgrowth from German GDP

would be an economic disas-ter, too. But in the U.S., withGDP at 3.3 percent in Q2 andheaded for 4 percent or morein Q3, the temporary reduc-tion in growth from the natu-ral disaster is manageable.

Here is where contextcounts. Anyone observing thedollar fall on Sept. 1 and 2could deduce the move wasunjustified based on the fun-

damentals and that thenews was being interpretedincorrectly. And the chartimmediately began to exhibita double top, which is one ofthe more reliable standardpatterns (Figure 2). If the pricefalls below the lowest point ofthe M (see mid-August), italmost always followsthrough with a substantialdrop. (A little move back

upward, such as the one that occurred on Oct. 6, is also verycommon.)

To draw a tentative conclusion: Currencies are joined atthe hip to the fixed-income and money markets because,after all, real capital flows are based on competing real ratesof return. But real capital flows constitute only a small por-tion of total forex trading and we often see forex pricemoves that are contrary to the rational comparison of finan-cial returns.

Other markets, such as equities, oil, and gold, are onlysporadically decisive factors in forex prices, and even thencan be exploited for their shock effect rather than any rea-

sonable and plausible economic scenario.You want to know what is right and reasonable in thefundamentals, but you shouldnt always trade on it rightaway when the market is in a perverse frenzy.

Institutional news

Institutional news has the potential to be the biggest moverof them all but, again, it is often used for shock effect to geta move that was already pre-ordained by the technicals onthe chart.

Consider the rejection of the European UnionConstitution. The first no vote came from France on May29. The Euro had already swooned from above 1.3600 to

THE BIG PICTURE continued

Forex prices move more on each of

the five days leading up to a FOMC

meeting than they do afterwards.

The Euro/dollar up move in early September quickly failed, and the market formed a

double top.

FIGURE 2 A PATTERN UNFOLDS

Source: Chart MetaStock; Data eSignal and Reuters



1.2535 on May 27, so it was hardly a surprise the publicsrejection of the constitution took the Euro further down to

1.2385 on May 31 and 1.2159 on June 1, when the Dutchvoted.

The failure of the Europeans to forge a constitution is areflection of dissatisfaction with the way the EU is workingand evolving, a malaise some analysts say could even spellthe end of the Union. Any system that delivers low growthand persistent high unemployment may have a humanesocial model, but it cannot be said to be a successful eco-nomic model. However, the Euro stopped dropping barelyone month later, in July 2005. Nothing had changed. Europewas still rejecting the principles of ruthless capitalism andmarket economics, still turning its head from competition

and open borders (for services, at least), and still (mostly)against enlargement to include countries like Turkey andeven the Baltic states.

Did traders forget the giant risk to the European experi-ment only one month after this stupendous failure? In aword, yes. And the reason is not hard to find the trainsare still running, the stock markets are open (and rising),banks are still busy acquiringone another, and businessgoes on as before. Most of all,nobody not even theItalians is seriously consid-

ering the death of the Euroand a return to the legacy cur-rencies. The Euro is a donedeal. The accounting has all been switched over, the oldbanknotes burned.

The market was willing torespond to the rejection of theConstitution right after thevote because it was consistentwith the trend already inplace, but it was unwilling to

let it hang like a stone aroundits neck for very long, espe-cially when the Euro wasapproaching the historiclow from May 30, 2004 at1.1760 (Figure 3). This level isvery close to the January 2,1999 euro launch rate at 1.1670and the opening price the nextday at 1.1786.

We have no idea why areturn to this level is being

resisted so strenuously, since

the euro traded under the launch rate for the rest of 1999 tonear the end of 2003, but traders got the idea in their mindslast spring the Euro should trade in a range of 1.20 to 1.25during summer 2005, and sure enough, any forays beyondthose boundaries have been short-lived.

The yield playing field

Finally we come to the main event the ever-rising yieldadvantage of the dollar over the Euro and yen. The newsevents associated with this rising relative return are theFederal Open Market Committee (FOMC) meetings the

continued on p. 28

The idea formed last spring that the Euro should trade in a range of 1.20 to 1.25, andany moves beyond those boundaries have not lasted very long.

FIGURE 3 TESTING A LEVEL

Source: Chart MetaStock; Data eSignal and Reuters

The forex market has a preference

for big events that are also a shock,

whether they are true and useful

information or not.



big Kahuna of events. FOMC meetings marry economic andfinancial expectations with hard institutional news.Everyone knows when the Federal Reserve will release its

decision, and since it started raising rates in June 2004, theoutcome has not been a surprise. All the same, youd thinkthe Feds periodic decisions would deeply influence pricesin the forex market.

Alas, you would be wrong. Using data prepared byStuart Johnston at TimeandTiming.com, forex prices movemore on each of the five days leading up to a FOMC meet-ing than they do afterwards. The Swiss franc, for example,has consistently moveddown more often than ithas moved up in everyfive-day, four-day, three-

day, two-day and one-dayperiod ahead of the past 62FOMC meetings. The aver-age move over the fiveperiods is 11.3 points.

On the day of the meet-ing, and in the one-day,two-day, three-day, four-day, and five-day periods after the 62 meetings, it has alsomoved down more often than up, but by tiny amounts 3.9 points, on average. Note that in those 62 meetings, theFed was not always raising rates; on many occasions, it was

lowering them.The same conclusion arises from examination of the data

for the Euro, Japanese yen, Canadian dollar, Australian dol-lar, and Mexican peso. The Japanese yen moves (usuallydown) by an average of 13.08 points per day on each the fivedays ahead of meetings and by a mere 4.32 points the day ofa meeting and the five days after it. In the Euro, the pre-meeting move is 29.4 points per day, and the post-meetingmove is 6 points. Of course, the swings are far wider theaverage disguises the range but the principle holds thatpre-meeting swings are bigger than post-meeting swings.

This means more than the market anticipates a move and

buys on the rumor. It means the rate-change FOMC event isnot news because it is not also a shock. This is a testamentto the good public relations of the Fed, but at the same time,it deprives traders of what should be a value-laden newsitem.

The forex market has a preference for big events that arealso shocks, whether they are true and useful information ornot. Some commentators in the forex market have taken tocombining all three sets of factors and weighting themaccording to riskiness. An abrupt rise in the price of oil, forexample, raises the level of risk. Risk-averse FOREX marketparticipants would sell dollars on a rise in the overall riski-ness of holding dollars, even when sound economic analysis

would indicate higher oil prices are no more damaging tothe U.S. economy than elsewhere, and maybe less so.

Another case comes from the institutional side of the

news. Last February when the Euro was falling, EuropeanCentral Banks (ECB) President Jean-Claude Trichet warnedthat the central bank could raise interest rates specifically toprotect the Euro from free-fall. The threat carried very littlecredibility but the Euro spiked upward anyway. Again inOctober, both Trichet and another ECB policy board mem-ber have made the same threat, this time with a little morecredibility since inflation is indeed on the rise in Europe,

although most money marketobservers think an actual ratehike is not going to occuruntil after the new year, if

then. And even if the ECBdoes raise rates, the U.S. willstill have a decisive yieldadvantage (200 or more basispoints) over Europe. Still, thepossibility of an ECB ratehike raises the riskiness ofholding a long dollar posi-

tions, so the news of a possible European rate hikeprompts a dollar sell-off.

But the market has again showed it likes the thrill ofuncertainty, and it responded by buying Euros even in the

last few days leading up to an FOMC meeting, where theoutcome is known. It is perverse to buy the Euro when thenext real-life central bank outcome favors the dollar; a signthe market is not operating on hard facts and clear-eyedanalysis, but rather thrill-seeking and using a rise in riskaversion to justify it. Its no wonder the chart sometimesseems to rule the interpretation of serious economic materi-al instead of the other way around.

Long run vs. short run

The best but by no means satisfactory conclusion isthat the fundamentals do not rule the market consistently

and reliably. Maybe the fundamentals rule in the long run,but the long run is nothing more than a series of short-runs,and in the short run, the market is often in the grip of a chartpattern that tickles the imagination, a rumor that defiescommon sense a story or scenario that is patently false,or just plain thrill-seeking.

In the end, the duel is not between the fundamentals andthe technicals, but between rational decision-making basedon facts and analysis, and traders who need to make moneyby going with the flow, even when that means taking seem-ingly irrational positions.

For information on the author see p. 6.

THE BIG PICTURE continued

The best but by no means

satisfactory conclusion is that the

fundamentals do not rule the market

consistently and reliably.


29/57
http://www.activetradermag.com/



Mario Kelly and Daryl Swain, forex tradersand principals of Wallwood ConsultantsLtd., put to lie the adage, Those who

cant do, teach.Formerly partners in a forex education and advisory

service, Kelly and Swain taught forex trading beforelaunching their commodity trading advisor (CTA) which, over nearly five years of trading, has posted somequite respectable numbers.

Through September, Wallwood was up 19.72 percent onthe year, placing it at the top of the Barclay Groups(www.barclaygrp.com) forex CTA rankings. The firms totalreturn since inception in January 2001 is 96.40 percent a19.29-percent compound annual return. Other than a 9.45percent loss in 2003 (the year they suffered their worst

drawdown of -32.27 percent), the firm has posted double-digit gains each year (Table 1).

Kelly and Swain, both 42, operate Wallwood from offices

outside London and in Spain. They trade exclusively in thespot forex market (typically using 6:1 leverage) and cur-rently manage $10 million. Figure 1 shows a VAMI chart ofthe firms equity growth along with that of the S&P 500 andBarclay CTA Index.

Kelly and Swain both have held various positions in theforex industry, and immediately prior to starting their ownbusiness, they were execution traders at CMC Markets, aforex trading firm and brokerage. They launched whatwould eventually become their CTA when they were (asthey say in Britain) made redundant in 1997. They decid-ed to set up a forex advisory and educational service, ini-

tially for some of their former clients.The business wasnt intended to be a long-term

proposition, according to Kelly. Although neitherone of them had managed money before, he andSwain were set on it, and they eventually begantrading their own funds to refine their tradingapproach.

Its all very well telling people how to trade, but we might as well do it ourselves and showthem what we tell them to do does work, Kellysays.

One of the advantages of their former positionas brokers at CMC, according to Kelly, was theygot to see the different missteps non-professional

CURRENCY TRADER INTERVIEW

Wallwood consultants

practice what they preachThese two former brokers and forex educators are posting some of the best returns of the yearamong currency money managers.


My impression is that a lot of

people tend to have more

money than sense when it

comes to trading.

Daryl Swain Mario Kelly
http://www.barclaygrp.com/http://www.barclaygrp.com/



traders often make.My impression is that a lot of peo-

ple tend to have more money thansense when it comes to trading, Kellysays. They make really basic mis-

takes, like not having stops in placeand leaving positions unattended.They dont realize what theyre doing.

The unique thing we had when wedevised our trading system is that wesaw a lot of [order] flows and a lot ofdifferent trading models, he contin-ues. You try to take the good bits ofmost of them. Our initial tradingmodel mainly looked at how clientstraded and avoided the mistakes theymade. It doesnt work totally we

have had our drawdowns. Its impos-sible to say youll win on every singletrade.

Kelly describes Wallwoodsapproach as essentially systematic with the exception of one discre-tionary analytical component witha primary focus on limiting losses,which they accomplish partly by limit-ing their exposure to the market. Theyenter the market on price breakouts(long or short), and then use a position-

management approach that incorpo-rates a trailing stop that tightens as aposition progresses.

We use a mathematically basedalgorithm that is, effectively, based onswing trading, Kelly says. If we expe-rience a certain amount of losses, wepull out of the market and then wait fora period before entering again.

CT: Is it fair to characterize your approach as a shorter-

term breakout-type system?

MK: Yes. It involves a bit of breakout, a bit of Elliott Wavewhen it comes to counting oscillations, and support andresistance. The MACD (moving average convergence-diver-gence indicator) is involved as well, once again in countingoscillations. Were not 100 percent governed by one thing.

CT: Support and resistance seem to play a pivotal role in

your trading. How do you define these levels? Is it a discre-

tionary process, or are you using some variation of standard

channel breakouts, or something else?

MK: By looking at charts, really. It is more discretionary,because it tends to be the two of us looking at the chart anddetermining the levels. Daryl might say, I think we need an

order at 1.1980. And Ill say,To me it looks like 1.1975.And either I persuade him orhe persuades me, or maybe

well split the difference.Lets say were out of the

market now (Oct. 4). Lookingat the Euro/dollar, wed prob-ably have an order at 1.1880on the downside and 1.1980on the upside. Were actuallylong the market at themoment at 1.1952, where themarket is now. (See Figure 2.)

CT: In terms of limiting your losses, how do you go about

setting stop points?MK: Theyre based on support and resistance.

CT: So, relative to a support or resistance level youre plac-

ing a stop

MK: between 30 and 60 points behind the market.

CT: What about taking profits?

MK: Were fairly unique in that we try to run the positionup until a set parameter.

CT:A profit target of some kind?continued on p. 32

Through the end of September, Wallwood

Consultants was up nearly 20 percent on theyear.

TABLE 1 WALLWOOD ANNUAL RETURNS

Source: The Barclay Group (www.barclaygrp.com)

Year Return

2005 YTD 19.72%

2004 42.63%

2003 -9.45%

2002 11.43%

2001 31.80%

Wallwood's performance is compared here (in terms of the growth of an

initial $1000 investment) to the S&P 500 (blue line) and the Barclay CTA Index

(green line).

FIGURE 1 WAL

november 2005 • strategies, news and analysis

Documents