British Pound Hits 26 Year High Vs. US Dollar

While I'm not currently trading the GBP, I thought this was an interesting bit of news - on Wednesday, April 18 the British pound hit its highest level versus the dollar since 1981, breaking $2.010 for the first time in 26 years. And here I am looking at daily, weekly and monthly highs and lows - sorta puts your own little trading timeframe in perspective.

The big rise against the dollar followed data out of the Bank of England showing inflation in the UK at 3.1%, which is way above the bank's goal of holding inflation at 2%. Traders are now guessing that the bank will raise interest rates to try and bring the inflation rate down - and with those higher interest rates will come more profitable carry trade opportunities for those buying the GBP. (The pound has long been a key component of most forex carry trading strategies.)

Hence this dramatic spike upward. Hope you GPB/USD traders out there made some pips off it!

Finally a little EUR/USD action! I was about to fall asleep...

So I've been sitting on a long EUR/USD trade all week getting more bored by the minute, and finally today the pair exploded upward through my limit order following the Federal Reserve's decision to keep US interest rates at 5.25%, based the weak US economic indicators and continuing inflationary pressures. The US stock markets are way up today as well, with the Dow Jones up over 1% at the moment.

Here's a picture of today's EUR/USD action from my daily charts, a dramatic contrast with the range-bound meanderings of the past several days.

And to think I was about to post about how bored I am with forex these days. Well, it's moments like these that keep it interesting. Now let's see if the market goes back to its tedious ping-pong match across a 50 pip range for the rest of the week. (Note to self: stop jinxing your trades by mocking the market.)

How undervalued is the yen?

I just read an excellent article in the most recent Economist discussing the undervaluation of the Japanese yen, which their editors assert is putting the global economy at serious risk. This story ties in closely with an earlier article about the carry trade, of which the yen forms an integral part because of low Japanese interest rates.

The Economist's take on the situation is that speculation by carry traders combined with complacency by world governments is holding the yen's value down at an artificially low level. How low? The article claims it could be undervalued by as much as 40% vs the Euro. That's a lot. And when the yen finally does begin to adjust upward (not if, but when), there are as many as $1 trillion in carry trade positions that will start unraveling with every pip it rises.

Say you've bought the GBP/JPY pair with a highly leveraged forex account and are making a nice profit off the dramatic interest differentials between these two pairs. Suddenly the yen appreciates by 1%. Then 2%. Then 5%. It's not a pretty picture. There's a reason this strategy has been called "Picking up nickels in front of a steamroller." So if you've been pursuing a carry trade system with the yen, this article is a compelling argument against complacency in your positions.

One of the most informative parts of the article for me was its discussion of how hundreds of billions of dollars in yen carry trades aren't closely tracked by official statistics. The reason for this is that unlike spot currency traders who will sell the yen to buy a higher yielding currency, hedge funds will instead use financial instruments called currency forward swaps to place their carry trades. How can you measure how much these off-balance-sheet transactions add up to? According to the article, "A better clue comes from record net 'short' positions in yen futures on the Chicago Mercantile Exchange. Estimates of the total size of the carry trade range as high as $1 trillion."

In short, it's well worth reading, whether you're a carry trader or just trade the yen on a regular basis. And even if you don't go near the yen in your trading, keep in mind that any major movement in this currency will have significant spill-over effects into others.

Here's the article: Carry on living dangerously

Fed Leaves Rates Unchanged - But Not My Charts

So the Fed Open Market Committee just announced they're leaving the federal funds rate unchanged at 5.25%. Here's what my charts look like for the past couple hours - volatility, anyone? Interestly, aside from those crazy whipsaws up and down, the price has returned to a point not terribly far from where it was before the announcement. This is a case where trading on the Fed news could've left you with painful losses as the whipsaws triggered your stops.

Let's say you'd been brave enough to trade on this news and had set both short and long limit orders with tight stop losses, say 15 or 20 pips in each direction. Unless you were wise enough to take profits fairly quickly and contented yourself with modest gains, those upward and downward spikes could've earned you losses on both the long and short trades as the market swung back and forth, setting off both of your limit buy and sell orders but never resolving into a clear trend that would actually make you money.

This is one of the reasons I'm very leery of trading the news these days. For the record, I've been short the EUR/USD since the weekend for technical reasons: on the daily charts, the price moved inside the upper Bollinger Band on Sunday, and that's what I've been trading on since then. After all this Fed fuss I'm still showing a 36 pip profit on that trade, and I'm glad I've got my stops set way up over 1.29, otherwise this could've been an ugly day. Now I'm hoping that original downtrend will continue when all the dust settles from this Fed announcement.

Related topics:

The Bernanke Bounce: Markets Rally on Fed Chairman's Inflation Comments

In case you're wondering why the currency markets went crazy today...the Fed raised rates

Fed Chairman Ben Bernanke's Speech at the International Monetary Conference

Fed Chairman Ben Bernanke on Energy Prices and the US Economy

Online Forex Interest Calculator

Every so often I get curious about how much interest I'm earning or losing by holding certain currency positions. For instance, I recently discovered I've shelled out a lot more than I've made in interest this year because I've been making a lot more long EUR/USD trades than short ones. Knowing that I can make a few extra bucks may also affect my decision to hold a position through the weekend or not. So I decided it would be helpful to have a handy calculator on hand that would tell me exactly how much I could expect to earn or pay out in interest.

Fortunately there's no shortage of these calculators online, and Oanda offers this easy to use one as part of its FXMath suite of currency trading tools. Curious how exactly interest is calculated, or perhaps you'd enjoy nothing more than calculating it yourself? Here's a detailed explanation of how it's done.

Related topics:
Forex Calculators & Converters
Learning about carry trades

In case you're wondering why the currency markets went crazy today...the Fed raised rates

Here's the Fed's statement on their increase of the Federal funds rate by 25 basis points to 5.25%:

"The Federal Open Market Committee decided today to raise its target for the federal funds rate by 25 basis points to 5-1/4 percent.

Recent indicators suggest that economic growth is moderating from its quite strong pace earlier this year, partly reflecting a gradual cooling of the housing market and the lagged effects of increases in interest rates and energy prices.

Readings on core inflation have been elevated in recent months. Ongoing productivity gains have held down the rise in unit labor costs, and inflation expectations remain contained. However, the high levels of resource utilization and of the prices of energy and other commodities have the potential to sustain inflation pressures.

Although the moderation in the growth of aggregate demand should help to limit inflation pressures over time, the Committee judges that some inflation risks remain. The extent and timing of any additional firming that may be needed to address these risks will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information. In any event, the Committee will respond to changes in economic prospects as needed to support the attainment of its objectives.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Susan S. Bies; Jack Guynn; Donald L. Kohn; Randall S. Kroszner; Jeffrey M. Lacker; Sandra Pianalto; Kevin M. Warsh; and Janet L. Yellen.

In a related action, the Board of Governors unanimously approved a 25-basis-point increase in the discount rate to 6-1/4 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis, Minneapolis, and Dallas."

Source: U.S. Federal Reserve

News on the Fed rate outlook, the US economy, and a strengthening dollar

Now I don't generally post much actual news on this blog, since as I explained in a previous diatribe I can't usually be bothered to trade directly on economic news -- rather, I focus on what, if anything, various technical indicators tell me the impact of the news has been.

But today this interesting Reuters article caught my eye. It's entitled "Dollar keeps gains as U.S. rate outlook reassessed" and it discusses how optimism about the US economy on the part of Ben Bernanke, US Federal Reserve Chairman and Greenspan successor, has led to a resurgence in the value of the dollar. Combined with a startling jump in core producer prices (PPI) in February, Bernanke's views suggest the Fed will be raising interest rates to 5% in the next month. All of which has helped send the dollar back upwards following last week's decline of over 2% vs six other major currencies.

Even if you spend all your days staring at charts and indicators, it's always good to poke your head out into the real world from time to time to see what economic factors are shaping the trends you see on screen every day. So read and learn, and then, if you're like me, go back to your moving averages, Bollingers, oscillators and all the other fun toys that make news look dull.

Article cited:
Dollar keeps gains as U.S. rate outlook reassessed