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Foreign Exchange

FX comment: Trying, and failing, to make sense of FX

Having been away for a few weeks I’m still striving to get some sort of understanding of what’s going on; actually, it’s nothing to do with my absence, I’ve been vainly trying to understand markets for the past 30 years.


John Authers’ piece in last week’s FT summed up the scene well, pointing out that the commodity/equity correlation is not entirely logical, and that the “indiscriminate” nature of the risk on/off mentality means: “We are still not yet in a world where the traditional investment game of identifying marginal mispricings will pay.”


But Authers sees FX as some sort of catalyst for change in other markets. He believes that some resolution of the logjam in FX (JPY strength must run out at some point, US/China tensions must get resolved, Eurozone and US prospects clarified) will give direction elsewhere: “What will move markets out of their ranges? Barring a significant geopolitical event, the best chance of a jolt comes from the foreign exchange markets...”


I don’t see it myself – FX has truly become an asset class in its own right and is merely another tool in the hunt for yield. It can just as easily succumb to knee-jerk risk-on/risk-off episodes as any other market.


Did the market take Basle III as risk-positive? It is hard to say – capital ratios were increased as little as can have been expected and full implementation is a long way down the road, making it good for bank shares but more questionable as a means of assuaging the next crisis. Chinese industrial production figures also came out on Monday, surprisingly showing an increase, and were probably deemed more market newsworthy than the Basle stuff. After a brief dip under 1.27, possibly on Landesbank worries, EUR/USD was firm all week and is around 1.31 as I write. AUD and NZD were as firm as you like, but then USD/CHF managed to breach parity for a while. Maybe risk had nothing to do with it and it was all an anti-USD thing in the face of QE2.


Wednesday morning provided the unusual spectacle of the FT’s Lex with foot firmly wedged in mouth. Noting that Japan’s prime minister, Naoto Kan, had seen off the challenge to his leadership, the column foresaw “problem number two – the dollar/yen rate, still testing new 15-year highs – the Japanese prime minister remains practically powerless. The traditional solution – intervention – is unlikely.” Unfortunately for Lex the Bank of Japan had intervened, at a little after 2am London time, on Wednesday morning: the perils of print journalism.


The prospect of a second dip in the US and the perceived necessity for another round of quantitative easing is probably the main market driver at the moment. So it is as it has been for quite a while: a soft dollar in FX, lower bond yields (currently recognized basket-case economies excluded), equities treading water at relatively healthy levels (the Dow has retraced around 50% of the high to low sell-off, the FTSE a little more), and gold rampant – money has to find a home – regardless of George Soros this week calling it “the ultimate bubble...it is not safe...it is not going to last forever” – quite right George, nothing ever does, but as you know well enough, this game is all about timing.


It doesn’t look as if there is yet much prospect of FX leading the way out of Mr Authers’ market malaise. Yet there is evidence that there is some significant contrary positioning (asset managers still holding short EUR positions on the IMM, risk reversals in EUR/USD and GBP/USD still firmly in favour of puts) and it could be that given as QE2 by the Fed is now seen so negatively the actuality might not seem so bad. We could then see another bout of “At least the US is doing something, decoupling is nonsense, everywhere else is going to get worse before it gets better – buy dollars”. Maybe.


Saying that, though, QE2 still looks like a desperate last-throw-of-the-dice type thing. An attempt to jump-start the economy with a semi-fraudulent boost to asset prices. Perhaps, despite Soros, closing your eyes and buying gold at the highs is still a viable response.


I’m quoting him somewhat out of context but Simon Derrick at BNY/Mellon, in a piece on the Japanese unilateral intervention and the unlikelihood of multilateral intervention, ends by saying: “...what this does highlight is that almost all the major nations at present would like to benefit from a more competitively priced currency; little wonder then that in the circumstances gold is trading close to all time highs.”


Yes, little wonder. Maybe it will all make a little more sense next week.

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