An FX Parity Play post Brexit

Could Brexit push EURUSD, GBPUSD, and EURGBP to Parity in 2020 …or sooner?

The tea leaves in the UK are wilting fast as the Brexit deadline is fast approaching. While goblins and ghosts will be meandering the streets in the US on Halloween night (October 31), the UK will be bracing for the scare of the century, namely, a possible departure from the EU. Leading the charge are two factors: Boris Johnson’s ego and the fear of Labor Leader Jeremy Corbyn becoming the next PM. Both outcomes are down right scary!

Mired within the cross hairs of British politics lies the uncertain future of Sterling and the Euro. Both currencies stand to lose value against the USD and other safe haven currencies, i.e. CHF and JPY). At the very least traders can expect lows to be tested once again. Here’s why…

Since Trump took office, investors have been living a new economic normal that has yet to be fully reflected in global currency values. As a result, central bank reactions have varied widely.

As of late… Mario Draghi has renewed QE efforts creating more ‘easy money’. Jerome Powell is patching up a US short term liquidity issue with a QE-like repeat performance. GDP numbers are dropping due to unresolved US-China talks on trade tariffs. Major European banks and pension funds are choking up against EU’s negative interest rates. Worse of all, global monetary policy tools that central banks once relied on to maintain economic stability are no longer effective. These and other factors are pushing economic leaders to compete on the basis of their devalued currency rather than optimal resource allocations and coordinated globalization.

This relentless ‘race-to-the-bottom’ syndrome among central bankers has investors worried and will very likely be the root cause for a potential parity FX play against the USD in the months ahead.

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© 2019 Tom Kadala

How to FX Brexit…

From the RagingFX Trading Desk…

The jury is finally out. Parliament has for the second time voted down Theresa May’s tentative Brexit agreement. Despite recently acquired legal assurances from Brussels of a limited back stop with Ireland, a major sticking point, the British Parliament would have nothing more to do with May’s two years of haggling with EU negotiators. What lies ahead is most certainly the growing uncertainty of the British economy.

Just as most FX traders have been baffled by the recent strength in the dollar, they have also shaken their heads in disbelief at Sterling’s rise. On the dollar, some argue that the dovish outlook from Powell and the disappointing 20,000 NFP numbers from last Friday hide the fact that the USD is fairing out better than its peers, …hence the show of strength is really ‘relative’ strength from an overall decline.

To some degree, could the same be said about Sterling’s recent strength? The UK economy is firing on all pistons fueled by historically low unemployment numbers and an increase in tax revenues from earlier this year. But, here is where the difference lies. Sterling’s ‘relative strength’ comes from an artificial demand founded upon frenzy, stockpiling efforts from both consumers and government buyers living in fear of a ‘no deal’ Brexit.

After March 29 when Article 50 is to be invoked, the British economy will return to a lower equilibrium point. The irony is that it no longer matters if Brexit is approved or not; nor if there’s a ‘no deal’ Brexit, a second referendum, or new elections. The damage to the UK economy has already been done, because it will take months to work through the artificially bloated inventory of goods, especially among soon-to-be tight fisted consumers living in fear of losing their jobs to a forthcoming recession. Add unprecedented political uncertainty of the likes not seen for decades and Sterling strength will undoubtedly be short lived.

On the near term, we expect Cable to trade with high levels of volatility within a 1.30 to 1.35 range to start. Over the mid term… look for eventual spikes to give way to a predominant downtrend where it will potentially test a 1.14 low.

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© 2019 Tom Kadala

Hanging in the Balance for FX Traders… Brexit, Trump’s Tariff Threats, and the EU’s unprecedented Plea

From the RagingFX Trading Desk…

Dominating headlines for this week include Brexit, China, and Germany. Here’s is our take for the weeks ahead…

On the Brexit front we anticipate an extension to the March 29, 2019 hard deadline for at least another year. The EU will be holding their elections in May, which will hamper a second referendum attempt. Keeping the status quo, at this juncture, we believe is what is best for both sides, which will most likely secure Theresa May’s role as PM for the near future.

This past weekend Germany caved after witnessing Theresa May’s historic Parliamentary loss of support for the current Brexit proposal. Merkel’s supposed successor, Karrenbauer, issued an unprecedented, emotional plea from the CDU asking the UK to reconsider reentry. The $120b investments and more than twice that in trade exchange value between both countries are weighing heavily on the minds of German leaders.

If you agree that Germany holds the purse strings for the EU, this gesture has significant ramifications politically. If cooler heads prevail, both sides will seek remedies behind closed doors that should buy more time for negotiations.

What does all this mean for FX traders?

Going forward, we see a global recession triggered by the tariff war between the US and China. This morning the latest IMF global predictions concur. China’s debt levels will continue to rise as the government continues to release more funds into the economy. The resulting inflation will depreciate the Renminbi against the US Dollar. In addition, the slowing Chinese economy will dampen commodity demand, which in turn, will hurt emerging markets, all of which will eventually lead to urgent bail outs of their respective dollar denominated liabilities. Those governments saddled with Chinese loans may have little recourse, since the IMF will not recognize Beijing’s competing alternative, the Asian Infrastructure Investment Bank.

In this economically declining scenario, the USD will remain strong at least for a few more quarters due to the current economic momentum. On the mid to long term, we would not be surprised to see the Euro reach parity with the USD as the EU seeks to rebalance its tariff-stricken industries.

© 2018 Tom Kadala

A FOREX Perspective on the US-China Tariff War

When the White House launched its first round of global tariffs to protect the steel and aluminum industries, they realized quickly that they had missed their intended target, China. After issuing a list of exemptions, they unleashed a second round of tariffs for $50b, this time aiming straight at China’s economy. The response from China came as expected in the form of a tit for tat. Trump then doubled down with a $100b tariff threat at China, where a similar response is expected soon.

What is happening behind the scenes?

Let’s start with a closer look at the import and export numbers between both countries. In 2017 China imported $130b of American goods, while the US imported over $506b in Chinese goods. The trade deficit of $376b no doubt can be viewed as a cause for concern. However, more revealing is the $130b figure because it represents the maximum the Chinese can retaliate against US imposed tariffs. Already with $150b on the line, the Chinese will have a net of $20b more in US tariffs to match. In essence the tariff war chess game between the US and China has reached a maximum ante even before negotiations have begun.

Two questions remain… What else can the Chinese do to match the US tariff burden? …and how exposed is the US economy if the Chinese tariffs are imposed?

Some have suggested that China could stop buying US debt. Such a move is unlikely because the dollar is expected to strengthen for two key reasons. First, US interest rates are on the rise in response to historically low US unemployments levels and, more so, from a broadened US economic recovery. Secondly, and perhaps least talked about is the repatriation of corporate funds overseas. Portions of a 3.5 trillion dollar corporate earnings kitty are being readied to return to US shores beginning in Q2, As this unprecedented flow of funds are transferred into US bank vaults, the impact from the increased demand for USD currency will be felt globally.

For now, China has no reason to sell its dollar denominated investments. The potential combination between increasing interest rates and currency appreciation is a formidable investment with low risk. As for US companies that will be impacted by Chinese tariffs, the net effect from having to pay a higher price for Chinese goods will be partially offset by their stronger USD earnings.

In light of this scenario, we expect the next wave of Chinese tariff retaliations may come in the form of a weakening of the Renminbi, hence, reviving the appeal for Chinese exports, while also maintaining the status quo with weakened non-USD currencies. A stronger US dollar against a weaker Renminbi could potentially be devastating for net exporting countries such as Germany. We expect the economic set backs could temporarily drive the euro below parity with the USD, while their economies adjust accordingly.

With the US corporate tax at a very competitive 21% rate, one could expect net exporters such as Germany to migrate their manufacturing bases and corresponding supply chains to the US. This trend has already begun and is expected to accelerate, especially if the US-Chinese tariff war continues unchecked.

© 2018 Tom Kadala

Powell’s Debut Rattles FOREX Currency Markets

Powell’s first news conference was definitely a switch from the scripted presentations given by his predecessor, Janet Yellen. Despite the difference in style, the message was clear: interest rates are on the rise, unemployment is at historic lows, and what remains to be seen are wage increases followed by an increase in productivity, otherwise, we can expect another recessionary pull back.

What does that mean for Forex traders?

Today we saw the dollar weaken against most currencies. At first it may seem counterintuitive for a currency with a rate increase to fall favor with traders, however, this anomaly is actually a repeat performance from previous USD rate rises. There are numerous academic arguments to support the pull back, however, our favorite is what we have heard from top traders at Goldman Sachs, “it’s just what happens.”.

From a more academic perspective, the 10-year T-Bills at 2.9% are teetering upon a psychological level of 3% where traders and investors believe the US stock markets may stall the longest bull market on record or even reverse it. Their argument is largely supported by the increasing default exposure from emerging countries such as Turkey, which have funded their long term projects with US Dollar denominated short term debt. As rates increase, their dollar denominated interest payments increase accordingly and become harder to pay back. The same is true with US credit card holders. In addition, as US consumer debt levels continue to surge, default levels may reach new levels at home, which could potentially stall the consumer retail engine that represents 70% of the US GDP.

With this unsettling USD backdrop, the GBP (British Sterling) is gaining unexpected strength against both the Euro and the USD. Recent developments between the two Brexit negotiators, Davis and Barnier, arrived yesterday with the usual British pomp and circumstance but in reality only delivered an extension of one year to the status quo. Some progress may have been made on some fronts, but the number of unresolved issues hasn’t changed significantly. Only the final Brexit date was moved to 2020. All of these shenanigans may be negotiating tactics of sorts, but at the end of the day, the feeling one can get from the very strained discussions between Westminster and Brussels is that eventually a referendum will be reintroduced in favor of the ‘Remains’.

Brussels’ negotiating tactics involve a high level of tolerance with little meaningful progress. They are letting this inevitable scenario play itself out. Unfortunately for Britain, when their leaders finally do choose to rejoin the EU (in whatever capacity), they will have gained less for their economy than what they had in place prior to triggering Brexit.

© 2018 Tom Kadala

Betting on the Brits – …my FOREX-related story

A couple of years ago I was asked to cover a trading desk at a prestigious firm in London. What transpired in the first week was quite humorous, since neither party really knew the other all that well.

During one of our daily banters at lunch break, I asked one of their top traders if it was possible for a random freelance writer, like me, to become an expert Forex trader like him and his colleagues, …in say, less than two years time? They chuckled, but soon the question turned into a friendly wager between us. They were willing to teach me the art of their trade, if I agreed to stay in London for a few months longer. Without any hesitation, I agreed. What I failed to tell them, however, (since they never asked) was that aside from freelance writing, I was also a seasoned programmer with over 25 years experience.

For the next three months, I watched two top traders work the Forex markets masterfully. In the evenings I diligently programed what I had learned into a versatile algorithm. To keep up with the trading lingo, I poured over technical trading manuals, took copious notes on their many trading styles and strategies, and carefully observed their trading behavior under many different circumstances. After a few days in the trading room, I quickly learned how these circumstances could vary widely.

Each morning we met briefly to review global events and discuss trading opportunities. Every meeting derived a different outcome. For example, one morning interest rates moved up in Australia causing investors to dump Euros and buy Australian dollars. The ripple effect triggered a similar outflow in Emerging Markets whose respective currencies sometimes reacted with greater amplitude. Within seconds, my two mentors were skillfully working the South African Rand and the Turkish Lira using Gold as a potential hedge. The Euros that were sold earlier in the day were bought back, all at a precisely calculated, risk managed profit. Later that week, changing oil prices, commodity prices, invasions, trade disputes, earnings, GDP, non-farm payrolls, hedge funding currencies, political elections, and so many other factors including the prospects for a Grexit and Brexit, weighed in. In an unpredictable manner, each event contributed to an uncanny sense of ‘controlled mayhem’ in the trading room.

Despite the daily ensued chaos from the markets, these two cool cats maneuvered skillfully through the maze pinpointing with incredible accuracy, areas with high-probability arbitrages. Like the rails on a train track, their unflinching trading discipline was solid and consistent, day in and day out. They reminded me of two sturdy pillars standing firm against a fierce tornado. It was truly amazing to watch and absorb, not just for what it did for their trading results, but more for the many ways it could be applied to daily life decisions.

Perhaps, my greatest takeaway from the entire experience could be summed up as follows:

“Add clear thinking, risk management, and a disciplined approach to any
problem and the odds for a successful outcome can be greatly improved.”

Simple? Yes, but very difficult to achieve on a sustainable basis, at least for humans, but not so for a pair of fast computers and a cleverly written algorithm. What happened next surprised us both. See for yourself at http://www.ragingfx.com.

So, you might ask, who won the wager?

As it turned out, we both did. …because we had unwittingly hedged our respective bets! They taught me everything they knew, while in two years time, I created an amazing algo that digitized everything they had taught me!

© 2016 Tom Kadala