Major Europe FX Pairs On The Precipice.....The CTA Nightmare To Continue

As the dust settles from the saber-rattling equities move of  ~11% (shocking to some), many CTA's are attempting to lick their wounds and regroup for a profitable rest of the year.

As they proceed down this path, there are a few other trend-following trades that are on the precipice of reverse and could prove to be obstacles to these funds' Pnls.

I believe we are near a meaningful reversal in the dollar versus developed Europe, namely EUR, GBP, and CHF.


How did we get here?

Well, back in 2017 I was a proponent for the major European currencies. I spoke extensively about GBP based on rate differentials here, as well as  EUR in a few posts here and here. Although were drivers in the currencies above, just as importantly was the dollar move that materialized after that time.

It was around this time last year.  Trump went around saying he wanted a weaker dollar. We had headlines like this:

Trump says the dollar is "too strong" -- good luck weakening it

Well, it turned out that he actually had pretty good "luck", since that turned out to be a major top in the dollar.


Where are we now?

Today, it seems that the unrelenting move in EUR and GBP has promoted participants to pile in on the long side for a number of reasons that could be broadly grouped together as the following:

1) Prospect of renormalization in monetary policies of non-US countries
2) Shifts in reserve policies in non-US countries
3) Higher beta to global growth in non-US countries

This line of reasoning and speculative FX market positioning has stretched so much that participants have hypothesized that things like interest rate differentials no longer work!

Yes, interest rate differentials as a signal for trading currencies go through prolonged periods of "working" and "not working" (my friend Goofy Man from a large macro hedge fund noted that 2004-2006 was a period when interest rate differentials did not "work").

However, we are at a point where I think the markets have over-anticipated and other fundamental factors beneath the surface of price action can trigger a reversal.

First, let's talk about rate differentials.

2yr notes in the US, UK, and Germany.

2yr swap rates in USD and CHF IRS.

Clearly, we see that rate differential in nominal terms has been stretched. In addition, FX cares even more about real rate differentials, which roughly reflect the same pattern, but could serve to explain why this phenomenon has failed to impact things until now.

Next, let's talk about policy.

When we look at some of these other central banks, we hear a somewhat similar, yet importantly different tone.

ECB:
As late as last week, the ECB stated that it was too early to review policy and that the latest it would even consider revisiting policy would be sometime "early this year".

As with most central banks, the surprise the world and rip rates mantra no longer exists and what we have in place these days is the announce, announce, and announce until finally ticking rates up at the slowest possible pace. So reasonable to say, the market has over-anticipated a bit here.

They've also expressed their intent on not targeting the exchange rate.

BOE:
We know they came out last month and stated that they could be moving on policy changes more swiftly than previously thought  (This was what I was looking for last year). There was a nice pop for GBP on the news. Now that the cat's out of the bag, we need to think about what they might do going forward.

As our very own Macro Man has documented, the BOE's flip-floppy nature, so that could be a risk.

Tying that to the price action - we have seen that GBP topped out right around that announcement. Not exactly a good harbinger for GBPUSD.

With that said, it is still important to keep in mind that trade-weighted GBP still looks cheap.


SNB:
The SNB has not shown clear signs of tapering yet. Not only that, they are trying to invest in stocks (sign of the times in 2018). Thus, the appreciation of CHF versus the dollar is probably not sustainable.



The Fed:
Lastly, thinking about the dollar leg.

We had the latest Fed minutes last week and Powell speak recently. They have made it abundantly evident that the Fed will do it's best to maintain it's attempt to continue its pace of hiking.

Breakevens have slowly started building a head of steam. There are enough stories delineating the tax cuts. I've detailed some of Trump's Fed choices in the past here. It is clear that we are starting to get a hawkish Fed. Shawn has recently put up details regarding some evidence of J-Powell's intents.

Finally, there's my favorite indicator - Jay Powell's height - he's over 6 foot!!

And a picture is worth a thousand words:


Finally, let's talk about Donald Trump who seemingly always does his best (whether intentionally or unintentionally) to keep things interesting.

Unlike this time last year, he and Steve Mnuchin has come out and said that they want the dollar stronger from these levels.

Here and here, etc.

Ironically, the market once again fails to pay attention to the most important man in America as he explicitly states his goals and intent (look, no mystery here).

With this combination of reasons in mind, I now turn to the dollar chart (using DXY as a proxy - which is mainly composed of EUR, JPY, GBP, and CHF)


Looks pretty clear to me that it is looking for a bottom. From this one should be able to construct clear entry and stop levels to either take profits if you've been riding the trend or to get into a speculative long position.

This has been such a persistent move for G10 currencies, it will be hard to see CTA's getting out of the way of this one.

And for the rest of us, good huntin'.


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Leftback
admin
March 1, 2018 at 4:10 PM ×

Yes. The dollar has bottomed. It will surge soon, as much through renewed global weakness as the US growth story.

The most likely next large group of speculators to be slaughtered are the Short Dollar crowd. Note that this implicitly includes the Cryptofreaks and the Goldbugs as well as the Long Euro crowd and the perennial Carry Merchants, i.e. long AUDUSD etc.

Secondary casualties would be EM equity and debt, the commodity complex, US small caps etc.. this is simple stuff.

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Shawn
admin
March 1, 2018 at 4:14 PM ×

"There is little evi...there is no evidence the economy is overheating." --Chairman Powell, in his senate testimony this morning. Perhaps that point, combined with some weak-ish data is supportive of "more hikes, but later rather than sooner," depending on where you think we are in the business cycle.

Re: the point on interest rate spreads, I think the move last year in USD was about relative return on capital. Often that has to do with interest rates, but sometimes it doesn't. But to your point, it is a mean-reverting mechanism--at some point it comes back to interest rates. Just my opinion, but I continue to believe the best investment opportunities are, and will continue to be outside of the US. That doesn't mean 3% long-term risk-free yields won't wind up being pretty attractive to foreign investors at some point.

Lastly, and dovetailing off that last point--"good luck weakening it." Gunning the deficit and domestic demand, with the subsequent significant impact on the current account, absent any increase in productivity sounds like a great way to weaken the currency. Rather amusing that a market commentator thought this would be a challenge, when Trump pretty much delivered on his campaign promises on this front. In all, this article is a great example of what happens when "experts" prognosticate.

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Shawn
admin
March 1, 2018 at 4:22 PM ×

@LB, AUD is negative carry for 1y, no? I have it as the worst performer over the last year on my DM FX board--I'm not convinced that's where the weak hands are positioned.

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Martin Ghoul
admin
March 1, 2018 at 4:55 PM ×

I really don't get the SNB point, tbh...

The SNB has been buying equities for quite a while now. That's simply an asset allocation decision for the portion of their reserves that aren't mon pol-related and there is nothing illogical or irresponsible about it. How does this imply anything for the USDCHF ecxchange rate?

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Detroit Red
admin
March 1, 2018 at 5:12 PM ×

Was looking at the major developed FX pairs in Europe. Wasn’t aiming to uncover some great insight regarding CHF, but was just commenting on their general central bank/policy direction.

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Leftback
admin
March 1, 2018 at 5:13 PM ×

@Shawn, you're absolutely right, I was actually thinking about CNY and typed AUD - force of habit from years of AUDUSD being the default carry trade of choice.



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Leftback
admin
March 1, 2018 at 5:17 PM ×

With regard to the SNB, one thing we have never seen in history is what happens when a central bank is balls deep in equities (esp. equities of a different sovereign, denominated in a different currency) and then there is an abrupt decline in that market so that the position starts to go bad. We are in uncharted territory here. The markets expect the SNB to hold, whatever happens....???

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Detroit Red
admin
March 1, 2018 at 5:18 PM ×

Although I would argue the asset allocation choice of the SNB to be novel to say the least and extreme to say otherwise.

It is reckless IMO and underscores the mindset of many central banks in this day and age. Reserves are suppose to be stable investments with diversification in an attempt to maintain value. Stocks are inherently risky. The fact that a portion of their reserves is in stocks is both madness unless you believe the era of low volatility is permanent.

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Nico G
admin
March 1, 2018 at 7:11 PM ×

they are absolutely terminating the DAX tonight

this is no small thing for Europe's leader

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Shawn
admin
March 1, 2018 at 7:28 PM ×

Ironically, Trump just found another way to weaken the dollar. Lucky! usd/mxn taking this far too well, IMO. And would 6.40 be too much to ask in usd/cny? Now that we're talking the same ccy, yeah, part carry, part momentum/reluctance or refusal to hedge USD liabilities. Can change quickly....especially when its so cheap!

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IPA
admin
March 1, 2018 at 7:46 PM ×

@Detroit Red, kudos on last year's DXY short! I also played it. My luck coincided with Trump's but it took two tries (with a stop loss on the first) and my target was 88.25 ;) I am still in the last (trivial) scaleout, and if you are correct on the reversal (while s/t bottom is in, that 91 res has to be more than just poked), I would get stopped out (still at a profit) on a trail to help me concentrate on bigger positions I currently run. But if not, I actually had a crazy 84 target to backtest the major level depicted on your chart. I really don't care at this point.

We have a bigger fish to fry. I have been yapping here about Trump possibly ending the equity rally he began and my wild prediction may be coming to fruition. Also, did Powell crap his pants a little and was backtracking today during Q&A after he saw the equities dive? Market doesn't care about him today as much, like I said, much bigger fish to fry at this point - trade wars.

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johno
admin
March 1, 2018 at 8:34 PM ×

China (or Chai-Na, as The Great Leader likes to say) not even in top 10 exporters of steel to US. Canada is #1. Apparently Trump gets his inspiration from South Park.

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Martin Ghoul
admin
March 1, 2018 at 9:32 PM ×

@Leftback and @Detroit Red re the SNB:
With all due respect, your concerns are unfounded and rather misguided, IMHO. You need to stop thinking of the SNB as a traditional central bank. In fact, the SNB is really now just another Norges Bank. Surely, there is nothing wrong with Norges Bank managing the Government Pension Fund and investing a large share of it in global equities? I don't think you could argue that Norges had done all that badly, all things considered. Moreover, they offer relevant precedent, as the fund's return was around -20% in 2008, in foreign ccy terms. This is precisely the model for the SNB and it's perfectly reasonable. In fact, it would have been silly of them to allocate otherwise.

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JohnL
admin
March 2, 2018 at 12:37 AM ×

johno, fun fact. 50% of US steel exports go to Canada. I believe there may even be trade deficit there. It'll be interesting to see how this plays. It may be a NAFTA move........

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March 2, 2018 at 2:00 AM ×

Dear Little Lefty, if you could send relevant paperwork related to , and only of what Kerry so kindly left me due to his unfathomable foresight in such matters of that time it would be appreciated to the extent that I will gladly be on my way.

Here is an address you can send said paperwork along with a short letter to the administration stating my name and student number :n9688471 with instructions to be passed on to moi.

QUT Business School
GPO Box 2434
Brisbane QLD 4001
Australia

PS: We're done here.Hand it over.

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Nico G
admin
March 2, 2018 at 3:02 AM ×

Trump got a letter the Mothers Against Canada

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Nico G
admin
March 2, 2018 at 1:09 PM ×

Dax is trading under February low

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johno
admin
March 2, 2018 at 3:36 PM ×

Continue to think we're still in bull market, but with a lot more chop for more modest returns. That's why I took profits in VIX futures instead of letting them ride earlier. Economic momentum has slowed at turn of year, globally. So digesting that, plus a Fed that will have inflation prints to justify at 4-hike-per-year pace. FRA-OIS front roll seems interesting. Got involved, but not much size because it's not my wheelhouse, at all.

Election of the weekend. Not so worried about Italy. Was more concerned about SPD, but latest YouGov poll had it at 56% for.

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johno
admin
March 2, 2018 at 7:13 PM ×

USDIDR seems interesting here. BoI intervening at 13,800-level. That intervention maybe a bit of a backstop near-term in case there's an unexpected upset over the weekend in Europe (and if no upset, EUR strength maybe generalizes to some USD weakness). GABI inclusion inflows coming April-June, though market is admittedly overweight Indonesian bonds. Already seen sell-the-news flows on the index inclusion announcement, I'd hope. Obviously, if the 10Y just blows through 3% and keeps moving, this isn't going to work out. Have put on mix of NDFs and options. Small.

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July 6, 2018 at 12:31 PM ×

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