Early Morning Thoughts (BOJ, JPY, CHF, CAD)
From Nic Lenoir of ICAP
First of all apologies for the lack of update the past couple sessions. I have been working on a model to price currency pairs based on the relative money supplies.
As argued over the past few weeks and first introduced in my piece "Catfight: it's on!" central banks are now engaged in modern monetary warfare. This was acknowledged just about that bluntly by the Brazilian central bank yesterday. There are two ways to play the game. The Swiss way, meaning traders front-run the central bank when their favorite FX dealer tells them the SNB is checking offers in EURCHF at which point you buy ahead of them and sell 2 hours later, leaving sell stops below the indicated support level the SNB is defending to get short when they give up. That's the easy one. What will the BCB be like? Should people buy 1.7050 banking on them being tenacious and waiting for a return of risk aversion to squeeze the shorts? Should they leave stop sells at 1.6900 to get short on a break? Probably a bit of both. As for the BOJ I reiterate my conviction that it should not be messed with at this point and I would much rather play alongside their bid. Indeed they have not only committed to an open period of intervention and have quite a few bullets left, but more importantly they have not sterilized their interventions. That to me means business: they print and they buy, they make the rules, don't challenge them under those conditions. In that environment, my belief is that relative monetary policies will drive FX moves. Currently there is 98% dollar bears based on the assumption the Fed will print at will. That to me is a simplistic view and I will be looking for mispricing to take the other side of the bet. The reason is that this argument does not factor in what other central banks are doing. Sellers beware: there is more to the picture than just selling the USD to play the Fed. I will send out a detailed analysis of my findings as I make progress in this domain.
The analysis will be all the more relevant as the economic cycle has rolled over, and now more and more economists are starting to see the light, led by best in class Jan Hatzius. The only thing holding risk appetite has been precisely USD weakness. I have attached my global liquidity chart which shows that gold or the Bovespa are nothing more than a function of the global liquidity in USD in the system. Bear in mind a large part of the value of the global liquidity index in based on the USD's strength or weakness. As such, if the Fed is relatively less proactive than other central banks in the monetary warfare (and there do not think outright size of policy programs but RELATIVE size as a percentage of the monetary basis) it would trigger a USD rally which will lead to a collapse of risky assets. The USD is the key to the puzzle in this new environment of weak growth and monetary warfare: it all starts and ends with the USD.
And now a couple charts that I find noteworthy waiting for more concrete results of my analysis that will lead to new trade recommendations. USDCAD as I indicated to a few clients yesterday tested the support of the recent wedge and bounced from 1.0220 about 1%. We would protect P&L by setting a stop at entry for those in the trade and in the money as there is a possibility to retest the 1.01 support below if our wedge assumption is erroneous. 1.06 is the key resistance for now. If bypassed expect USDCAD to rally hard and high. The reason why CAD has not part-taken unch to the recent greenback beatdown is that crude has underperformed most commodities. At least there is one commodity that is priced based partly on supply and demand! It can be argued crude is forming a diamond top as a friend pointed out last night, so we will keep a close eye on both crude and USDCAD.
Also while I remain bullish on US Treasuries ever since the failed attempt at breaking out lower in April, and more recently when we recommended buying 10Y Treasury futures at 123-00, in the very short term I feel that we possibly have completed and initial bullish impulse. That is confirmed by my observations on the bund as well where we seem to have completed a 5-wave motive from the buy level at 129-10. I have attached the 30-minute and 3-minute chart. A break below 125-11 will confirm a retest of 124-04 which is as of now where we will be looking at buying. This equates to 130.21 in the Bund.
Good luck trading,