Dollar and Yen on Fire, But For How Long?

Dollar and Yen on Fire, But For How Long?

By Ed Ponsi

The plunge in EURUSD has Americans everywhere asking one very important question: is it too late to catch a flight to Germany for Oktoberfest?

Greetings from London! We are living and trading in historic times, as the credit crunch has thrust the U.S. Dollar and the Japanese Yen into the stratosphere, while crushing the British Pound, the Euro, and other major currencies. To get a feel for the scope of this move, let's have a look at the monthly chart of the Great Britain Pound – U.S. Dollar chart (symbol GBP/USD). We can see that the GBPUSD rally, which lasted for the better part of this decade, has given back the majority of its gains in just three months. A drop of nearly 4000 pips has sent the pair crashing through all of its major Fibonacci support levels.

London is one of my favorite places to visit, but it's even more fun for an American like me when my currency has some real buying power. For example, a nice meal at the pub next door to my hotel still costs about 30 GBP, same price as usual. Last November, when the GBPUSD exchange rate was about 2.10, that meal cost $63 (30 x 2.10 = 63). Now that the exchange rate has plunged to 1.60, that same meal, as measured in U.S. Dollars, costs just $48 (30 x 1.60 = $48). Now take that meal and multiply it by all of the goods and services that Americans purchase from the U.K., and you get a feel for the size of this move, and the impact it has on these two countries.

Of course, the rise of the dollar is not contained to the British Pound; the rampaging U.S. currency has also undone most of this decade's Euro rally as well. The plunge in EURUSD has Americans everywhere asking one very important question: is it too late to catch a flight to Germany for Oktoberfest? Sadly, the answer is yes. If it seems like it's only been a few months since the once-mighty Euro was smashing it's way to new all time highs vs. the greenback, that's because it really has been just a few months.

The buck is rallying due to frazzled investors dumping shares and stashing the proceeds into U.S. Treasuries, one of the best ports for financial safety in any storm. When you buy a Treasury, you are really lending money to the U.S. government. The vast size of the U.S. government's debts makes for a huge, liquid market in U.S. Treasuries, where institutional traders can ride out the storm. For more on this topic, check out last week's article "Forex and U.S. Treasuries".

Although the USD has rocked the house recently, there is another currency that has been so strong, it has even beaten the buck. Of course I'm talking about the Japanese Yen, which has been on an incredible roll vs. the rest of the world. The Yen has performed particularly well against the Great Britain Pound, which comes as no surprise to regular readers of this column. Two weeks ago, we walked readers through a short sale trade of GBPJPY, and in an early September article we laid out the technical case for shorting this currency pair, followed by another article that presented a fundamental argument for selling it. Well, I don't think anyone could have anticipated what a fantastic pair this would be to sell short, as GBPJPY crashed to multi-year lows. Once again, thanks for your kind words and congratulations to all of you who shorted GBPJPY along with me

I'm sure many of us wish the GBPJPY Express would continue its southbound trek, but nothing lasts forever. While its way too early to call an end to the trend, its might be difficult for the Yen to keep this pace due to the threat of intervention by the Bank of Japan and other Group of Seven central banks. In other words, Japan is threatening to sell the Yen in massive quantities in order to weaken it, causing pairs like GBPJPY to rise. Because Japan has an export based economy, a strong Yen is bad for business, as big exporters like Toyota and Canon are losing sales due to the falling exchange rates of USDJPY, EURJPY, and GBPJPY. Japan may even get help from other G7 countries in weakening its currency, according to an October 27 statement from the G7 itself. This rare currency volatility warning by the G7 has been interpreted as a sign that Japan and others may step into foreign exchange markets and artificially force down the Japanese currency if the Yen continues on its current rampage.

"We are concerned about the recent excessive volatility in the exchange rate of the yen and its possible adverse implications for economic and financial stability," said the G7 statement. While this may sound innocent enough, the implications of the statement are huge. If Japan intervenes, the real winner will be the U.S. Dollar, the currency that the Bank of Japan (BoJ) is most likely to buy in mass quantity as it is selling Yen. If the BoJ starts pushing USDJPY higher, do not get in the way – in its last major intervention, the central bank caused USDJPY to climb about 700 pips over a three-week period in early 2004.

Last but not least, thank you for all your kind comments and emails regarding my recent series of appearances on CNN. Yes, it was a blast and as you can tell, I loved every minute of it.

Ed Ponsi

Forex and U.S. Treasuries

Hola from Mexico City! It seems that the markets are interconnected to a greater degree than ever before – last week's article on the Dow/ Japanese Yen trade is just one example of this phenomenon. With that in mind, I have a great question from a reader this week regarding another important relationship - the impact of the buying and selling of U.S. Treasuries on the Forex market. Here it is!

Q) Hi Ed, I follow your work and it's provided some very good insight. I have a two-part question. With all the short term volatility we're seeing, I read that the TED spread is one of many good barometers for this. In order to gauge the next stage in the cycle should we be looking at the 2 year or 10 year Treasury to gauge what's coming 6 months to a year from now? Also, how are the Treasury yields interpreted? Thanks for your response.

Ed Ponsi) Thank you for your question, I'll take part two of the question first. When it comes to interpreting Treasury yields, there is an inverse relationship between price and yield. In other words, when the price of the bond rises, that bond's yield falls. For example, let's say that you purchased a new bond with a yield of 4% at a price of 100, also known as "par". Let's assume that a year passes, interest rates rise, and new bonds come available that yield 5% at par. Well, assuming that the safety and the maturity date of the bonds are similar, the 4% bond is no longer as attractive as the 5% bond. You can't sell the 4% bond for 100, because bond buyers will simply opt to purchase the higher-yielding 5% bond at the same price. So, you must sell the bond at a discount price. To the new purchaser, his return on the 4% bond is actually closer to 5%, because when it matures, the bond he purchased at a discount (less than 100) will be worth 100. This makes up for the fact that the bond yields only 4%.

The recent fear that has gripped global markets is reflected in all maturities of U.S. Treasuries, but especially on the short end, for example the 3-month Treasury bill. Why is so much of the action contained in the near-term maturities? Imagine that you are a hedge fund manager, and you want to protect your clients. You simply want to get out of the markets and stash that cash in a safe place. You start buying 3-month Treasuries (T-Bills), because no matter what happens, you are going to get all of your money back at par within three months. Fund managers, investment bankers, and other investors, both individual and institutional, have been piling into T-Bills at an incredible rate – they have been buying, which drives the price higher and the yield lower. Here is a chart of the yield of a three-month T-Bill (see figure 1).

Figure 1: The yield on 3-month T-Bills craters in mid-October. Source: theFinancials.com

Last week, the yield on 3-month T-Bills dropped to virtually nothing. Investors were scooping them up anyway, because in a risky environment such as the one we're in right now, the philosophy of "better safe than sorry" is the way to go. Investors enjoy the certainty of knowing that no matter what happens to the price of these investments between now and the maturity date, they will mature at par.

The same can be said for the 2-year and 10-year Treasuries, but that is a longer time to wait and a lot of opportunities missed until maturity. So traders who opt for Treasuries with longer maturities have "price risk" – if they want to free that capital to invest at any point prior to maturity, they will have to take what they can get on the open market when they sell those Treasuries. Short and long term maturities offer the certainty of knowing that you can get your capital back at par, but many of the current buyers of 2-year and 10-year Treasuries will not wait until maturity to cash out. Somebody out there has been buying 2-year Treasuries, as evidenced by the chart (see figure 2).

Figure 2: 2-year U.S. Treasuries rise in price as the credit crunch intensifies. Source: Saxo Bank

This is a weekly chart of the price of 2-year U.S. Treasuries. The huge spike that appears to occur in late 2007 is a "bad tick" and should be ignored. A rising price indicates that investors are buying, and as the price rises, the yield is falling. Notice how the price begins to climb in the summer of 2007 - right around the time when the word "subprime" entered our vocabulary. Prices fell (and yields rose) in early 2008, as markets calmed down a bit, and then prices began to rise again (driving yields lower) this summer as the crisis became full-blown with the collapse of Lehman Brothers.

Regarding the TED Spread, which is explained in this previous article, it is a terrific way to gauge market fear, much like the VIX (volatility index). Both have come off of extreme highs, showing a possible light at the end of the tunnel for equity markets (see figure 3).

Figure 3: TED Spread drops suddenly, indicating greater confidence in bank lending. Source: Saxo Bank

It appears that banks are now more willing to lend money than they were last week, when the TED Spread hit its recent peak. Still, the level of fear is much higher than normal. Prior to the collapse of Lehman in September, the TED spread was about 1%. If it falls back into that 1% range, it will indicate that confidence has returned, and that the worst of the credit crisis may have passed. That would bode well for stocks, and bond prices would likely fall as traders pull money out of Treasuries and put that capital to work in the equity markets.

Have a question about Forex trading? Send an email to info@fxeducator.com and we may use your question in an upcoming newsletter. Until next time, best of luck to you in trading.

Ed Ponsi

The British Pound Gets Pounded

Tomorrow, I'll fly to London, a place I visit often on business. For many Americans, London has been as expensive place to visit during the past few years, but it's becoming cheaper by the minute as the British Pound has plunged beneath $1.63.

This represents a drop of 48 U.S. cents since the Pound peaked at $2.11 back in November. That might not sound like much, but in the highly leveraged world of Forex trading, it is a huge move of 4800 pips. A big chunk of that move, about 1000 pips, has occurred over the past three days.

What is wrong with the British Pound? Well, Prime Minister Gordon Brown has made it clear today that the U.K is heading into a recession, echoing comments made earlier this week by Mervyn King. King, the Governor of the Bank of England, also commented that the U.K.'s banking system was closer to collapse earlier this month than it has been since World War 1.

The amazing collapse of the British Pound has unwound most of the currency's gains for this decade against the U.S. Dollar. Measuring from the low point of June 2001, when the GBP/USD pair reached a nadir of $1.36, and the highs of November 2007, above $2.11, the pair has lost more than 60% of this decade's gains. It smashed through Fibonacci levels all the way down, falling like a piano pushed off of the top of the London Eye (see figure 1).

Figure 1: GBP/USD breaks all major Fibonacci levels on the monthly chart. Source: Saxo Bank

GBP/USD Chart

So where will the Pound go from here? Major support is located in the $1.55 area, which last acted as support in 2003. The rate of decline here is astounding, and traders who buy GBP right now might be catching the proverbial knife. I'll short rallies, if there are any to speak of.

If the entire civilized world is falling into a recession, why is the Pound taking it on the chin? The Bank of England's Monetary Policy Committee has simply been too slow to cut the U.K.'s benchmark interest rate, which remains at 4.5%. The MPC's reasoning is that it must control inflation, but with world markets collapsing and crude oil falling below $70 per barrel, the pendulum has shifted and the time for action has come. In my opinion, the MPC should immediately cut by another 150 basis points, but that's highly unlikely. I'm looking for more downside on the Pound.

One final note, I'm scheduled to appear live on CNN Business International on Monday, Nov. 27. See you then!

Ed Ponsi is the President of www.FXEducator.com and www.EdPonsi.com. He has appeared on CNN, CNBC, the BBC and Fox Business News, and is a frequent guest lecturer at trading events and seminars around the world. Ed has advised hedge funds, institutional traders, and individuals of all levels of skill and experience. Ponsi is featured on the FXEducator.com DVD series, Forex Trading with Ed Ponsi, and is the author of the best-selling book Forex Patterns and Probabilities

Using Stocks to Trade Forex

How can traders use recent stock market volatility to make money trading Forex?

CLICK HERE to read the article!

Light at the End of the Tunnel

Forex traders have been enjoying incredible volatility lately – provided that they’ve widened their stops and targets. Moves of several hundred pips in one hour are not uncommon, while similar moves used to occur over the course of a day. I’ve been trading the Japanese Yen against the British Pound (GBP/JPY) recently, taking advantage of the weakness in the U.K. economy (and by extension, the Pound) and the fact that the Japanese Yen Loves Misery. There have been plenty of opportunities to sell this pair, which has stabilized - at least temporarily – in the 170’s.

Figure 1: GBP/JPY downtrend has stabilized for the moment. Source: Saxo Bank

GBP/JPY Chart

Using this downtrend as a guide, I’ve been selling the GBP/JPY pair short when the 14-period Relative Strength Index (RSI) indicates that the pair is overbought in the short term. RSI exists on a scale that runs from 0 to 100, with readings above 70 indicating an overbought situation, while readings below 30 point to an oversold situation. A buy signal is given when RSI crosses above 30 after passing below, and a sell signal is indicated when RSI crosses below 70 after passing above. Since the currency pair is in a downtrend, I’m only interested in the sell signals, and I ignore the buy signals. This prevents me from trading against that fierce downtrend that is so clearly indicated in the daily chart (see figure 2).

Figure 2: Two sell signals and one buy signal on GBP/JPY hourly chart. Source: Saxo Bank

GBP/JPY Hourly Chart

How long will this continue? Well, there may be a light at the end of the tunnel. For the first time in weeks, we are getting word that banks are lowering the rates they are charging each other for 3-month USD loans. If this keeps up, expect the credit crisis to ease, and the Yen to reverse. Also, there might be a double bottom forming on the GBP/JPY daily chart (see figure 1). But for now, it’s too early to call the top on JPY, so until the Yen shows some technical weakness, I’ll continue to buy it vs. GBP and EUR.

Ed Ponsi is the President of www.FXEducator.com and www.EdPonsi.com. He has appeared on CNN, CNBC, the BBC and Fox Business News, and is a frequent guest lecturer at trading events and seminars around the world. Ed has advised hedge funds, institutional traders, and individuals of all levels of skill and experience. Ponsi is featured on the FXEducator.com DVD series, Forex Trading with Ed Ponsi, and is the author of the best-selling book Forex Patterns and Probabilities.

Hang 'Em High!

Hang 'Em High!

By Ed Ponsi

Ed Ponsi examines the Congressional grilling of Lehman Brothers' former CEO, and asks the question: In 2008, is it a crime to have money in America?

The other day, I was placing a short on GBP/JPY, trying to determine the exact location of my stop, when I heard the voice of defeat bleeding through my speakers. It was Richard Fuld, disgraced former CEO of the now-bankrupt investment giant Lehman Brothers, explaining himself before a Congressional committee:

"I want to be very clear, I take full responsibility for the decisions I made and for the actions I took. I feel horrible about what has happened to the company and its effects on so many."

I think it's a great idea to have a committee to determine what went wrong and how a similar boondoggle can be prevented in the future. I sure would like to know the rationale behind the investment grade ratings that were placed on toxic subprime paper. But most of all, I'm interested in learning if Mr. Fuld and his associates at Lehman looted the company on their way out the door. But the committee didn't seem interested in getting to the truth, or in finding solutions. Instead, the committee seemed intent on punishing Mr. Fuld, well, for being wealthy.

Enter Henry Waxman, D-Calif., chairman of the House Oversight and Government Reform Committee. Waxman repeatedly asked Fuld if it was true he made between $400 and $500 million running the company since 2000 – as if Fuld's impressive compensation somehow implied guilt. Waxman listed Fuld's collection of property – including a $14 million dollar ocean-front villa in Florida and a home in the exclusive ski resort of Sun Valley, Idaho. "You and your wife have an art collection filled with million dollar paintings." Waxman said. The chairman seemed more concerned with outing Fuld as a rich guy, as opposed to exposing any wrongdoing.

What is the point of these questions? Are we trying to convict this guy of having money? If so, he's guilty! But in the America where I live, it is not a crime to have money.

There are rumblings of shady dealings in the final days of Lehman, most notably the steering of millions of dollars to executives as the firm was in full collapse. The company allegedly sought $23.2 million in "special payments" for three outgoing executives just days before the collapse, according to internal documents. This disgusting act is the equivalent of looting a gravesite. If that happened, then any and all of the Lehman perpetrators should be prosecuted to the full extent of the law. String em' up! If Fuld was involved, I look forward to seeing him take the "perp walk". He'll have an awfully hard time enjoying that ocean front villa from behind bars.

I'd just like to point something out – Fuld did not benefit from the collapse of Lehman Brothers. In fact, he lost a great deal of his own money, along with his job and his reputation. Fuld still holds about 10 million—now worthless—shares in the firm. Think about that for a second; he lost 10 million dollars for every one dollar decline in LEH stock, which traded near $70 per share about a year ago. That's a loss of nearly $700 million dollars! That had to leave a mark, even for a guy like Fuld. Don't get me wrong, he won't be dining in a soup kitchen any time soon, but that's got to hurt!

Fuld owned all of the wonderful things enumerated by Waxman long before Lehman fell. As far as we know right now, he did not benefit in any way by being the captain of a sinking ship, or by becoming the butt of a million jokes, or by becoming a dark footnote in U.S. financial history. Soon after the bankruptcy announcement, Fuld was allegedly punched in the face by a co-worker in the Lehman gym. Journalist Vicki Ward told CNBC, "He was on a treadmill with a heart monitor on. Someone was in the corner, pumping iron and he walked over and he knocked him out cold.” Ouch!

Yes, he has a lot of money, and that seemed to be the point of Waxman's line of questioning. Fuld would have a great deal more money right now if Lehman hadn't gone under. Why was money the focal point of Waxman's questions? Perhaps Mr. Waxman believes that the public is bloodthirsty and wants revenge, that we can be lured into class warfare, and that we are not concerned with the facts. And while Waxman set the tone, this "Hang 'em high" mentality is also evident in the questions of the other members of the committee. If Fuld committed any crimes – if he was involved in the heinous act of steering millions to executives as Lehman fell – then could we please talk about that, and not simply beat the guy up for being rich? If any crime was committed, then that should be the focus of the discussion. Let's not pretend that it is a crime to have money in America.

Investment Terminology 2008: It's a very good time to be a trader, but maybe not such a good time to be an investor. Still, with the way markets are behaving, those of us who wear both the trading and investing hats could use a reason to smile right about now. On that note, thanks to one of our readers for sending this to me via email:

CEO = Chief Embezzlement Officer.
CFO = Corporate Fraud Officer.
VALUE INVESTING = the art of buying low and selling lower.
P/E RATIO = the percentage of investors wetting their pants as the market keeps falling.
BROKER = what my broker has made me.
FINANCIAL PLANNER = a person whose phone has been disconnected.
STANDARD & POOR = description of an investor's life in general.
INSTITUTIONAL INVESTOR = a frustrated investor who's now locked away in an institution.
MARKET CORRECTION = something that occurs the day after you invest in the market.
CASH FLOW = the movement your investment makes as it disappears down the drain.

Have a question about Forex trading? Send an email to info@fxeducator.com and we may use your question in an upcoming newsletter. Until next time, best of luck to you in trading.

When Central Banks Attack

By Ed Ponsi, President, FXEducator.com

New York City - After yesterday's barrage of rate cuts, today we are seeing salvos fired by the central banks of Hong Kong (50 bps to 2.00%), Taiwan (25 bps to 3.25%), and South Korea (25 bps to 5.00%). This comes hot on the heels of yesterday's simultaneous cuts by the ECB (100 bps), the Fed, the Bank of England, and the Bank of Canada (50 bps), and many others.

All of this cheap money is wonderful, but even if all of the world's central banks cut rates to zero, banks would still be reluctant to lend money. As the old saying goes, you can lead a horse to water, but you can't make that horse lend money to banks at reasonable rates. Or something like that. Nobody is going to put a gun to a banker's head and force him to lend money. Nobody wants to be the last person to lend money to the next victim, the next Bear Stearns or Lehman Brothers.

For evidence of this, take a look at the Ted Spread, a fear gauge that climbed to its highest point in a decade just after the announcement of the joint central bank action. The Ted Spread is the difference between LIBOR and the yield of the 3-month US Treasury, and yesterday it climbed above 4%. This means that banks are demanding 400 basis points above what they would receive from the Treasuries, which have no risk. For most of this decade the Ted Spread has lingered beneath 1%. Banks are demanding higher rates to compensate for the perceived risk of lending to financial institutions.

One final thought; the cover of Time magazine features a Depression-era photo of men crowding in line beneath a sign that reads "Free Soup". I'm not one to call tops and bottoms, but if history is any guide, this could be an early sign of a bottom. Historically, excessive exuberance or excessive pessimism, as reflected by magazine covers and other forms of pop culture, are signs of a market turn. In late 1999, as the Nasdaq was rocketing to a gain of over 80% for the year, magazine covers featuring bulls were all the rage. There were even two prime time TV shows about Wall Street and the stock market. Needless to say, one year later, nobody wanted to talk stocks.