The Forex Nitty Gritty

A higher Euro Zone current account surplus is good news for those concerned about a possible downward direction of the Euro. According to press reports, the higher Euro Zone current account surplus is largely because of increased exports or goods and services. This indicates a stronger economy that many anticipated in light of austerity measures being put in place across the continent. The Euro Zone’s current difficulties started with the 2008 market crash which ushered in the worst global recession in three quarters of a century. Many Euro Zone budgets were dependent upon continued strong growth as debt levels were high throughout the Euro Zone.

A couple of years ago it came to light that five members of the European Union, Portugal, Ireland, Italy, Greece, and Spain were, to varying degrees, at risk to default on their national debts. They were nicknamed the “PIIGS” group. Greece became the focus of international attention as the worst case scenario. After receiving more than $100 Billion in funds two years ago the country was at risk for being unable to pay for expiring government bonds in March of 2012. The drama leading up to this date drove the Euro up and down depending on if the news for a successful bailout was positive or negative. In general the order of the day was how to short the Euro.

Along the way to a successful bailout by other members of the Euro Zone, the European Central Bank, and the International Monetary Fund, there were riots in Greece over lost pension and health care benefits. Countries across the Euro Zone agreed to reduce their national budgets and abide by austerity measures in order to avoid a spread of the Euro Zone debt dilemma from the Southern tier of nation to the more prosperous economic core of the Euro Zone. The austerity measures are likely to cause a recession in the European Union, according to many economic forecasters. The recently higher Euro Zone current account surplus, therefore, is excellent news for an economy wracked by doubt and debt as it tries to claw its way out of what has come to be called the “Great Recession.” The issue of the day may well become how invest in Euro.

For those Forex trading the Euro a higher Euro Zone current account surplus indicates a stronger Euro, but that is not all there is to the story. The price of the Euro is driven by whether more folks want to acquire Euros or more folks want to get rid of Euros. The current account surplus for the Euro Zone could have been if not for outflows of investment as many have avoided putting their money in the Euro Zone. For example, those who received payment for their maturing bonds in Greece may have taken a fifty percent hit on capital. Those folks may well have moved their money out of Euros and into, what they may feel to be, a stronger currency. Although the Euro Zone may be producing products to sell throughout the world, worldwide investors may well not trust either European banks or many European countries when it comes to paying their debts. A higher Euro Zone current account surplus does not necessarily mean that there will be no new recession in Europe. If, for example, European imports of products from China and other parts of Asia drop off substantially, a higher Euro Zone current account surplus could be maintained even with a shrinking economy.

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As the Greek debt dilemma finds resolution, currency traders wonder if there will be similar Euro Zone support for Portugal debt relief. Both Greece and Portugal are part of the so called PIIGS group. Portugal, Italy, Ireland, Greece, and Spain all have been in danger of defaulting on their national debts. The situation was sufficiently bad in Greece that it required the largest government bailout in history, cobbled together by the various solvent members of the Euro Zone, the European Central Bank, and the International Monetary Fund. In addition, private investors in Greek bonds took a fifty percent reduction in bond value and gave Greece longer to repay in return for the country not simply refusing to pay. The problem for the remaining PIIGS nations will be getting credit at reasonable rates. Anyone buying Portuguese bonds may be thinking that in return for a few percent interest each year they will be running the risk of having their bonds written down by fifty percent or losing their investments completely. Euro Zone support for Portugal debt relief will be important in the country is to avoid the debt default that many feared for Greece. Then traders will want to consider what the Euro Zone debt resolution will mean for the Euro.

Portugal, Recession, and Its Debt Burden

The country of Portugal has a continuing recession with a one percent drop in GDP in 2011. It is expected to have as much as a four percent drop this year and perhaps another two percent in 2013. With the Greek scenario as a backdrop, Portugal will have trouble finding any private lenders to help it out. Although economists expect Portugal to emerge from its recession within five years, that does not encourage investors at this point. Thus Euro Zone support for Portugal debt will be critical in the coming years. If the solvent so called core group of European Union nations are willing to support Portugal in the coming years it will likely emerge more fiscally sound. In addition, the austerity measures taken on by nations across Europe may well lead to slower than expected European growth in the year or so to come. This would simply make things worse for Portugal and the other nations struggling with their debt burdens.

Trading the Euro

It appears that the European Union is not going to break up, as some feared a year or more ago. However, fears of a “domino effect” of debt defaults from Italy to Spain to Portugal to Ireland and back to Greece still concerns traders and investors. The answer for the currency trader, in this situation likely lies in how the European Central Bank is dealing with the generalized debt dilemma. The European Central Bank seems to be following the lead of the United States Federal Reserve in that they are printing money in order to pay off debts, prop up banks and the credit system, and stimulate the various economies. This approach may well pay off in pulling the Euro Zone out of its economic funk. However, the cost could well be a devalued Euro. However, if you expect to see a downward direction of the Euro look at who else is printing money to stimulate economies these days. The dollar and Yuan could fall as well. As always don’t trade currencies unless you understand what you are doing and always do your homework.

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Will there be a significant Forex response to slower Chinese growth? That question came to mind after Chinese Premier, Wen Jiabao, told a Communist Party Congress that the government will set a lower growth target for this year than for last year. This is the first time in almost a decade that China has done this. Whether or not there will be a Forex response to slower Chinese growth depends, first of all, on whether or not setting a lower limit to growth will really slow the super-heated Chinese economy. These continue to be boom times on the Chinese mainland, at least compared to virtually everyone else. The growth downgrade is a reduction of predicted growth from eight percent last year to seven and a half percent in the coming year. Even a small percentage decrease in economic productivity amounts to a lot of money for the world’s leading exporter. The Forex response to slower Chinese growth will likely hinge on a reduced flow of foreign exchange into China, any modifications to China foreign investment limits, and the overall  state of the world’s largest economies, North America and Europe.

There are two parts to this puzzle, from the viewpoint of timing. The Chinese premier has just made an announcement and there is a Forex response to slower Chinese growth rate predictions. But, the announcement may be premature. Europe may rebound. The USA may come out of the recession faster than expected. If these things happen, China will likely see continued high exports to the two leading world economies. If that turns out to be the case, there will likely not be a big drop in China’s rate of growth, at least not in the short term. However, markets become saturated with Chinese products. China’s growth may end up being like that of Microsoft, very fast to a point. When there is no more demand for products from China there will be a falloff in Chinese economic growth. A that time the Forex response to slower Chinese growth will be based on actual import/export figures and not on official pronouncements.  Other issues such as the distinct possibility of a Chinese real estate crash could over shadow a slow and steady Forex response to slower Chinese growth.

As always with foreign currency trading, there is the initial perception and initial change in market sentiment. What follows will depend upon whether or not initial perception matches reality. One scenario can lead to a Forex market rally and the other can lead to an abrupt market correction. How to trade Forex successfully is to keep in touch with both the fundamentals the drive a Forex response to slower Chinese growth and the technical signs that herald changes in market sentiment. Because fundamentals can change quickly many traders simply use Forex technical strategies as their primary tool in dealing with issues such as the Forex response to slower Chinese growth or the downward direction of the Euro due to severe austerity measures in the EU.

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The servicing costs for Italian debt just went down after a promising Italian debt auction. Just last month Italy had to offer over six percent interest in order to sell bonds to refinance its debt. This month the rate fell to five and a half percent. European Central Bank loans were believed to be largely responsible for the promising Italian debt auction. At the time of a Moody downgrade of European national debt ratings the European Central Bank issued half a billion Euros worth of loans to banks on the continent. Some of this increase in liquidity was apparently responsible for the fall in interested rates from the last Italian bond auction. Italy sold €3.75 billion worth of ten year bonds. Sale of all bonds came to €6.25 billion.

The promising Italian debt auction is good news for the European Union and for the Euro. Last fall many wondered if Italy would follow Greece into default and cause in irreparable rupture of the fabric of the European Union itself. Stabilization of the debt picture in Italy as well as the rest of the so called PIIGS group (Portugal, Italy, Ireland, Greece, and Spain) could bode well for a stronger European economy and a stronger Euro. As Italy continues to refinance its debt, Forex traders will watch to see if it is able to convert more and more of its debt to longer terms. Other issues for those wishing to trade the Euro will be a continued low European Central Bank rate. The European Central Bank seems to be following the lead of the United States Federal Reserve by purchasing government notes. This serves to drive down interest rates and in turn provides a necessary economic stimulus.

Over the long haul the effect of printing money to buy bonds, stimulate the economy, and pay off national debts may have the effect of driving the value of the Euro downward. However, currencies are traded in pairs and if everyone else is using the same strategy the Euro may not suffer. The Euro, dollar, Yuan, pound, and other currencies may fall versus commodities but not versus one another. Another issue that looms over the promising Italian debt auction in Europe is fiscal austerity that countries across the continent are adopting in order to manage their debt burdens. Many believe that the end result of too much belt tightening will be a recession in the coming year or two. There are those who believe that a Euro Zone debt resolution will only come paired with a recession. However, a cheaper Euro will make European products more competitive on the world stage. Stronger exports by Europe could be the ticket to an economic recovery. Certainly exports have been the answer for economic growth across Asia. A promising Italian debt auction could be just the beginning of a fall and then long term recovery of the Euro. As always we are not suggesting that Forex traders trade the Euro or ignore the currency in trading. We offer this dissertation as an example of thinking through the factors that drive currency rates.

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Will stringent Greek debt writeoff requirements solve the problem of Greek and European debt? What will the Greek debt writeoff requirements do to the Greek economy? Will the Euro benefit from a Greek austerity plan, French austerity plan, Italian austerity plan, and austerity plans across the board in Europe? The Greek debt dilemma is really only the tip of the debt iceberg in Europe and across the globe. Because Greece is a member of the European Union, there is concern among EU members that if Greece defaults on its debt obligations that other EU nations will follow and lead to a breakup of the European Union. The other members of the EU, the European Central Bank and the International Monetary fund are pledging money to cover Greek debt obligations that come due in March of this year. One of the aspects of this scenario is a writeoff of part of the Greek debt. Greece will have less debt to pay off, hopefully a longer time to do so, and help in covering its debt obligations. But, there will be more than one price to pay.

Creditors are demanding that Greece make changes so that its economy will be more competitive as part of the Greek debt writeoff requirements. This including privatizing many government run industries and services. The Greek parliament just passed a set of very stringent austerity measures. However, they have yet to be implemented and countries such as Germany, who will obligated for a large portion of the bailout funds, are demanding implementation of these same austerity measures before bailout funds can be released. The current installment comes to about €130 billion or $172 Billion in USD. The money will be used for successive payments, the first being just under €15 Billion in late March of this year. Required cuts in spending include subscription drug benefits, pensions, and subsidies to nationalized industries. The problem for Greece will be to maintain a reasonable level of employment and collect a reasonable amount of taxes or these selfsame austerity measures will reduce the amount of money that Greece needs to pay its debts just as things are starting to look better. For Forex traders the currency rate instability of recent months may not let up until the Greek situation is stabilized.

The main point of all of this for the Forex trader is that the Greek-European-international debt dilemma is far from resolved with satisfaction of the Greek debt writeoff requirements. A recent Moody downgrade of European national debt ratings was visited on more than a dozen nations. The US saw a Capitol Hill farce last year when an otherwise routine increase of the US debt ceiling nearly caused a shutdown of the US government and resulted into US debt rating being downgraded! Forex traders will be wise to look to just how nations such as the USA are approaching their massive debt burdens. The current chairman of the US Federal Reserve, Mr. Bernanke, has developed a set of solutions dubbed the Bernanke Doctrine. A major part of this plan to keep credit flowing and maintain employment is to drive interest rates to a bare minimum This done by purchasing US Treasuries with printed money. The low interest rates help preserve a slow economic recovery. The printing of money is meant to accomplish two things. One is to replace some of the trillions of dollars of equity that evaporated during the 2008 market crash and its aftermath. The other is an intentional effort to devalue the US dollar which also reduces the value of US debt obligations. As the European Central Bank and China follow some the same principles Forex traders will wait to see which currency falls faster. The Greek debt writeoff requirements may end up as small potatoes compared to measures taken by the giant economies of the world to shuck their debt burdens.

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When trading foreign currency trading volume can be critical to liquidity, accuracy of technical analysis and profits. Recently released trading figures from the London Forex market provide insights into when trading volume is high or low.  Foreign currency trading volume peaked in the fall of 2011 as concerns about the Euro Zone debt crisis drove trading. According to the recently released report trading last fall was only surpassed by foreign currency trading volume in April of 2011. The three most commonly traded currency pairs are the Euro versus the dollar, the US dollar versus the British Pound, and the US dollar versus the Australian dollar, in that order. Besides the Euro Zone debt crisis the tsunami in Japan led to a peak in trading. That was in April of 2011 when G7 economic ministers threatened to intervene in currency markets to stop the rise of Japan’s currency due to massive Yen repatriation. Other factors include companies hedging risk in foreign trade and investors fleeing to safe havens in time of economic risk. And, let us not forget that when central banks such as those of Japan and Switzerland choose to keep their currencies from rising too rapidly then can intervene in currency markets and markedly increase volume.

For the average currency trader anticipating changes in foreign currency trading volume allows him to trade the most active, and hopefully most profitable, currency. High trading volume implies interest and interest comes from volatility and potential profits. Traders use both fundamental and technical analysis to choose their trades but often time they use foreign currency trading volume as a guide to which currency they ought to be trading that day, week, or month. Whatever might be the Forex response to Persian Gulf tension traders can find profits as the dollar, Euro, Pound, and other currencies adjust to the threat of new economic realities.

However, reading figures for Forex trading volume after the fact does not help a trader gain profits. Rather the trader must watch the news, follow economic policy of more than one nation, central bank statements, and world events in general for assistance in predicting Forex trends. The backbone of the foreign currency trading system is comprised of companies and nations which must buy and sell internationally. The Forex market was set up to allow for foreign trade. Currency speculators enter this worldwide market in search of profits. Their presence helps improve liquidity in markets and also serves to increase foreign currency trading volume. But the mere presence of speculators in currency markets does not necessarily lead to peaks and valleys in foreign currency trading volume. It is world and national events, adjustments in national, economic, and monetary policy that drives comparative currency values. Remember that no one trades one currency. All currencies are traded in pairs and it is the factors of that drive each currency and how these factors compare, currency to currency, that drive the price of one currency as denominated in another. Traders are wise to look for a peak in trading volume as a guide to where to trade. Then the trader still needs to do his homework in order to buy or sell in a timely manner.

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Is Euro Zone debt resolution on the horizon? If so how will Forex markets react? The good news is that the majority of Euro Zone countries have agreed to strict austerity measures and debt talks between Greece and its private creditors are progressing. However, the ever so slow progress towards Euro Zone debt resolution always seems to take two steps forward and one backward. The downward direction of the Euro may or may not be ready to reverse. Currency traders always keep fundamentals in mind and these may, finally, be improving. However, market sentiment is something else. Currency traders as well as investors in stocks, commodities, and real estate have been pretty beaten up over the last couple of years in persistently volatile markets. As the Euro Zone gets its act together, will market sentiment coalesce to create a stronger Euro? Or, will the likelihood of a mini recession due to fiscal discipline scare investors and currency traders alike and result in a continuing decline of the Euro.

Traders who wish to trade the Euro, as well as the US dollar, Chinese Yuan, and a number of other currencies will want to keep in mind that everyone is printing money as a remedy to debt, unemployment, and reduced trade numbers. Forex trading and economic news are always intertwined. However, part of the currency trading puzzle is less obvious. As an example, US treasuries are selling at historically low interest rates. It turns out that a major buyer of US treasuries is the US Federal Reserve. This is part of the so called Bernanke Doctrine. Fed chairman Bernanke is considered one of the world’s experts on the causes of the Great Depression. He is applying measures meant to avoid the same sort of devastating economic contraction as happened in the 1930’s. His measures will tend to keep credit flowing, keep interest rates low, and steadily devalue the US dollar. A major aspect of this is that the Fed used recently printed money to buy US treasuries and to purchase other assets. The European Central Bank is following a similar course and China is said to be financing internal construction projects the same way. A Forex trader will see two forces in motion in the case of Euro Zone debt resolution as well as the US economic recovery, more jobs and currency devaluation.

On one hand traders will review how to invest in Euro and on the other hand those seeing the printing presses run at full speed will continue to consider how to short the Euro. Both approaches may be successful but, if so, it will be a matter of timing. In the short term a policy tailored after the Bernanke doctrine coupled with fiscal discipline may well lead to a timely Euro Zone debt resolution. However, a Euro Zone debt resolution purchased by virtue of the printing press will devalue the Euro over time. Then, the third aspect is that a cheaper Euro will make European products more competitive and lead to a stronger European economy and a rebound of the Euro. Forex traders need to stay tuned in to the evolving Euro Zone debt resolution in order gain profits.

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Although companies doing business internationally prefer stable currencies, speculators commonly look for profits in currency rate instability. The situation in the European Community is a case in point. A collection of European nations are to varying degrees in danger of defaulting on their national debts. The worst of the lot is Greece. There has been speculation in the press that the nation might be forced to withdraw from the European Union and quit using the Euro as its currency. For the last two years EU officials, the International Monetary Fund, the European Central Bank, and a succession of Greek officials have been dealing with the crisis. The end result is still uncertain. The continuing result of this uncertainty is currency rate instability. It starts with the Euro. However, the collective EU economy is on par with that of the USA as the first or second largest in the world. A financial crisis, renewed recession, and/or political breakup in Europe will affect markets and currencies throughout the world. Efforts to avoid financial disaster such as the French austerity plan threaten the economic growth needed to pay back the accumulated European debt load.

The most recent news about Greek debt negotiations is that European finance ministers are demanding that private investors take a fifty percent write off on the value of their investments and that they extend their loans out to two or three decades. In return the EU solvent members of the EU will provide the funds to rescue the Greeks from their financial mess. The precise interest rates involved in a new set of loans is a bone of contention as higher rates would require more money than the EU at large is willing to offer up to fix this mess. The Euro has fluctuated up and down in response to these ongoing negotiations, ministerial pronouncements, and press reports. Those who have been able to accurately read the various pronouncements have been able to profit from the resulting currency rate instability. It is not just about how to short the Euro but how to anticipate a likely recovery when the EU gets its economic house in order.

What happens if there is a Greece debt default? The concern is that many European banks as well as other investors have purchased Euro denominated bonds from Greece. If the nation defaults on its debts the resulting losses could cause banks not to loan and large investors to hold on to their money. If this happens in Europe, Spain, Italy, and even France could have problems selling their bonds at auction at reasonable rates. The doomsday scenario in this case is that government default on loans rolls across the bottom of Europe ending up in France, the continent’s second largest economy. The European Union breaks up with only the northern members remaining. The resulting currency rate instability drives the Euro down. The resulting recession in Europe hurts Asian exporters affects the Yen, Australian dollar, Yuan, and Rupee. Currency traders who do not see the whole picture sustain large losses. Those who anticipate the fallout from a poorly handled Greek debt crisis profit from the resulting widespread currency rate instability.

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Many who follow the real estate market on the mainland would not be surprised to see a Chinese real estate crash. Although some still think of China as an unstoppable juggernaut, the nation has its share of problems. For example the large number of IPO’s of Chinese stocks last year were mostly unsuccessful. The US Securities and Exchange Commission is looking into the limited transparency of and poor data available for many Chinese stocks. A likely recession in Europe could not only create problems such as a run on French banks but would certainly reduce exports from China as well. Both the EU and United States are printing money in order to avoid a depression. Cheaper dollars and Euros will make European and North American products more competitive and Yuan denominated products harder to sell. Then there is the issue of skyscrapers and a possible Chinese real estate crash.

Building booms often precede bad economic times. The “see throughs” in Atlanta and Houston years ago were silent testimony to the hubris of overbuilding during times of loose credit and excessive optimism. (A “see through” is a skyscraper that is largely unoccupied. At sunrise and sunset one can “see through” the many empty floors.) China is said to have over half of the skyscrapers in the world in construction with more on the drawing boards. Even for a large and growing economy that is a lot, especially when financing may be questionable. Property developers in general are pessimistic while construction firms express optimism. One group might be expecting a Chinese real estate crash while the other does not. However, when a construction company finishes the job it gets paid and moves on. It is the developers and investors who suffer when the real estate market crashes. At such times predicting Forex trends can be profitable.

There are three more issues that relate to the danger of a Chinese real estate crash. One is that in an effort to stimulate the economy the Chinese government has built many public projects with hundreds of billions of dollars creating their own artificial boom. The second is the nature of financing in China. Similar to Japan before the bust two decades ago, China has all too many “off the books” loans or at least loans that are not apparent to the general investor. If things go bad they could do so in a hurry with shaky financing. The third aspect is that the Chinese real estate market is already heading down hill. Residential property sales are down substantially in major Chinese cities and sellers are dropping prices in order to get out before things get worse. As the China current account surplus falls so might property values throughout China.

So, what would a Chinese real estate crash mean to the average Forex trader? The global economy is interconnected. Problems in Europe lead to problems in China and problems in the USA lead to problems virtually anywhere in the world. The coming year could be one of extreme volatility of foreign currency rates. The general consensus is that the Euro will fall due to a recession in Europe or a recession avoided by printing money. The seemingly impervious Chinese Yuan could fall as well, or at least level off due to decreased exports. It could get worse if the scenario of a Chinese real estate crash turns out to be the case. Then there is the issue of social and political unrest. The Arab world is not the only place where people have grown tired of heavy handed autocracies. People often put up with bad government when they can put food on the table and rise up when the economy turns bad.

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The European Central Bank rate of interest on loans to client banks may fall in the coming year. The new European Central Bank president, Mario Draghi, is expected resemble US Federal Reserve Chairman, Ben Bernanke, in his actions, more so than his predecessor, Jean-Claude Trichet. Draghi, like Bernanke, studied at the Massachusetts Institute of Technology. With Greek debt default still a strong possibility the EU has given the bank broader powers to prop up banks as well as governments. There are two problems that leaders of the EU and the Central Bank face. One is that governments across the continent need to spend less. We see this in the recently announced French austerity plan. The other is that decreased spending could well drive the continent back into a recession. It appears as though Draghi may follow Bernanke’s lead in driving interest rates lower in an attempt to avoid recession and increased unemployment by cutting the European Central Bank rate among other measures.

There is, indeed, speculation that Draghi could find himself following the Fed example of buying government bonds as well. The new bank president has already surprised many by issuing 1% interest loans amounting to over $600 Billion USD to prop up ailing European banks. The end result of all this could well be a yearlong decline in the Euro. Currency traders and others can heartened by the prospect of the EU getting a handle on the debt crisis. Over the long term, a solution to the continental sovereign debt dilemma can only mean good things for the EU. However, it may well be a bumpy and somewhat downward ride for the Euro until the EU gets its house in order. Volatile foreign currency rates were the hallmark of last year and may well continue into 2012. A reduced European Central Bank rate may well lead to a long term solution but at the price of declining Euro in the year or years to come.

If the Euro does decline it will probably not fall all at once or at a steady rate. Trading options on the falling Euro may be the best trading bet. When the trader buys calls or puts on one currency with the other he limits his investment risk to the price of the options contract. Traders will be able to decide upon trades based upon solid fundamental and technical analysis. By purchasing options the trader will be able to avoid substantial losses if his analysis is faulty. On the other hand he will be able to leverage his investment by purchasing options as the cost of an options contract is substantially less than the cost of the underlying currency. As always we are not predicting that the Euro will fall but offering a thought process for traders to follow in developing and executing currency trades. If the impression that Mr. Draghi gives of following in the steps of Mr. Bernanke is correct that will give traders useful insight into the likely direction of the Euro in 2012.

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