Boris and Kathy's FX Blog www.bktraderfx.com

Last week, we said that volatility was back, but this week, it seems to have gone into hiding once again. The only volatility that we saw was on intraday price action which was kind enough to spike us out on multiple occasions. Most of the currency pairs licked their wounds this week and recovered some of the past week’s major losses. The question on the forefront of everyone’s minds must be whether the carry trade liquidation is over.

To answer that question, we must look at what happened this past week:

1) Reserve Bank of New Zealand raised interest rates by 25bp to 7.50% and signaled that more rate hikes are in store
2) European Central Bank raised rates by 25bp to 3.75% but signaled that they will hold rates steady in April
3) Bank of England left interest rates unchanged > Lots of strong data
4) Stronger US Non-Farm Payrolls reduces chances for an August rate hike, but US Sub-Prime lending sector is really in trouble
5) Canada and Australia both reported solid economic data

And what we are expecting next week…

1) The Swiss National Bank to raise rates
2) And the US to report a number of key releases including retail sales, PPI, and CPI

Oil prices increased 15% in Feb, which indicates that both PPI and CPI could be strong.

Where does that leave us?

The high yielding currencies (New Zealand, Australia, Canada and US Dollar) have the data to put an end to the carry trade liquidation, at least for the time being. US retail sales are the only problem since Wal-Mart reported a drop in sales due to the wintry weather (remember, February was one of the coldest months on record). If we get a strong number on Tuesday, then we have the all clear to jump back into carry trades. However it is the Yen that will be sold rather than the Swiss Franc given the Swiss central bank’s plans to raise interest rates.

Even though a lot of high brow economists have compared the latest liquidation to 1998, where we saw a 20 percent collapse in USD/JPY, we think that conditions now are very different. In 1998, the sell-off and risk aversion was driven by Russia’s default on its international debt and the collapse of Long Term Capital. This time, the liquidation was driven by overvalued stock markets. What we have is more of an orderly correction, of which the average move has been 8.6 percent. To read more about this, see our special report, “Is the Carry Trade Liquidation Over?”

We also want to point out that the Dow / USD/JPY relationship that we talked about in our last report is still very much in place (“Dow Down 400 Points, Dollar Falls to 12M Low against Yen - Is This a Major Pivot Point into a Recession?”)

That is, the movements in USD/JPY have foreshadowed movements in the Dow.

Now onto our trading:

Last week, trading was easy. The trends were clear and the moves were big, giving us over 120 pips in gains. This week, the range trading environment and the intraday spikes have made trading far more difficult, leaving us down 83 pips.

Short USD/JPY +31

When the markets opened on Sunday night, the liquidation from the prior week continued. Strong capital expenditures data and nonchalant comments from the Japanese government sent USD/JPY tumbling from 116.60 to a low of 115.13 in a matter of hours. After the data, we caught a part of that move and banked 31 pips relatively quickly.

Short EUR/CAD -44

This trade was one of the most painful trades that we have had. On Monday, we went short EURCAD at 1.5441 with a stop at 1.5485. On 2 occasions there were quick spikes, once to 80 and once to 86. Some of our traders got stopped out on the first spike, we didn’t, but on the second spike, we were stopped out while others weren’t. What happened? EURCAD is a less traded currency pair which means that brokers have different spreads and vary on pricing. The tighter spread brokers kept the traders in, the wider spread ones, stopped them out. After hitting a high of 1.5486 (one pip above our stop), EURCAD sold off to 1.5368. If it wasn’t for the spike, we probably would have lowered our stop and banked some part of the 70 pip profit. In retrospect, EURCAD is indeed a hard pair to trade given the sharp divergence in spreads between brokers – next time, unless we a super attractive opportunity in the pair, we may just avoid it.

Short EUR/USD -29

We sold the Euro on the expectation that the ECB would tone their comments and move to neutral at their policy meeting. Although this was the case on Thursday, we were early to the trade by selling the Euro on Monday. The rebound in EUR/JPY was so strong that it sent Euro soaring, stopping us out for a loss of 29 pips.


Long USD/CHF + 5

We went long USD/CHF because Swiss GDP came out strongly while US unit labor costs was weak. Although we liked the trade, we ended up closing it out at breakeven.

Short USD/CAD -37 pips

On Wednesday we went short USD/CAD on the back of stronger Canadian data and weaker US data. Once again, the movements in the Japanese Yen sent CAD/JPY tumbling, dragging USD/CAD up with it. The fundamentals that we were looking for did not convince the market until Friday, when the break in USD/CAD finally happened. We were stopped out of the trade for 37 pips.

Short EUR/USD -9 pips

Our final trade of the week was short EUR/USD. We had difficulty getting into our trading station after the NFP number, causing us to get a much worse fill than we wanted. We went short EURUSD because the strong NFP would delay any plan for the Fed to cut rates while the comments from European Central Bank President Trichet signaled that they would not be raising rates again in April. We still like the EUR/USD short, but as per our general rules, we do not hold positions over the weekend, which is why we closed the trade for a minor loss of 9 pips and will revisit it on Sunday evening.

We have kept our losses relatively small, which is why we are still quite positive year to date. Limiting drawdowns will make it easier to recover from a series of losing trades. Looking ahead, after this past week’s rather boring economic data, next week we are expecting a ton of data that could bring back market volatility. Check out our Calendar for all of the potentially market moving events.