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Monday December 22, 2008 - 04:27:22 GMT
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The Silly Season



In journalism it is the month of August when all the newsmakers are on vacation. The business movers are in the Hamptons, the political shakers are back in their Congressional districts but the print pages and websites still need to be filled with copy. So writers dig deep into human interest, a dog hero here a quintuplet there, perhaps a fish and cat love story. Stories that would never see the light of day in another season are front and center above the fold.

Currency traders may not be keying on trivial stories masquerading as financial news but they have their own silly season. It is the last month of the year and particularly the last two weeks of December. The volatility in this holiday month can be quite extraordinary, the ranges well beyond the normal. If the markets are not quite exaggerating unimportant news to market moving status they are certainly putting far more energy into their interpretation.

From 2:00 pm on the 16th of this month until 3:00 am on the 18th the euro rose more than 900 points against the dollar, from 1.3770 to 1.4718. By noon of the next day, the 19th, it was back at 1.3824. A total move of more than 1800 points ending in almost exactly the same place.

Of the fifteen trading days in December there have been two 300 point days, three 400 point days and two five hundred point days. Last week the euro traded more than 400 points every day except Monday which saw a mere 340 point range. On Tuesday and Thursday the united currency moved more than 500 points.

What is going on here? Are the markets chock full of dramatic developments? Is this foolishness? Perhaps, but only in the sense that whatever direction the market takes in December is usually reversed in January.

There is of course a reason for all this volatility—liquidity--or rather the almost complete lack thereof. The largest players in the currency markets, the banks, close their books for December. Their traders stop quoting outside the firm’s own customer book. The same is true for most major funds and proprietary trading firms. But financial news does not halt for the holidays, especially this year. When news does hit the market there is much less potential deal volume to absorb whatever trading interest exists and fifty point moves turn into two hundred.

There is no clearer model of the mass participatory nature of trading markets. Without the majority of players one or a few may drive rate levels. And the resulting currency rate reflects those few inputs not the decision of a market.

Because of the negligible liquidity and the absence of the majority of the currency market’s major participants rate decisions reached in December rarely stand. Witness the trading of history of the past five Decembers.

In December 2007 the euro plummeted from a high of 1.4769 in the first week to a low of 1.4309 in the third. In the following three weeks it reversed up to 1.4921.

In December 2005 the euro fell from a high of 1.2058 in the first week to 1.1777 in the last week of the month. But at the start of the New Year it switched gears rising to 1.2181 and continued higher to 1.2322 by the last week in January.

Trading in December 2004 exhibited a similar pattern. From a low of 1.3139 early in the month the euro climbed to 1.3665 on the final day of the year. But by the end of the first week in January it had sunk to 1.3025 and continued falling to 1.2731 by the second week of February.

In December 2003 the euro rose from 1.1937 in first week to 1.2910 on the first trading day of the New Year. It then suffered a month long drop to 1.2218.

Only December 2006 does not conform to this pattern. From a high of 1.3366 during the second week of the month it dropped to 1.3090 by the final week. It then continued to fall in the New Year to a low of 1.2865 in the second week of January.

The reason for these reversals is simple. The market movement in December represented only a small fraction of the market opinion. Most institutions and traders are on hiatus. If few are playing then the opinion expressed is, you might say, not representative of the whole. When the mass of traders return in January they have, in four out of the last five years, expressed an opinion different than the conclusion of December. In four out of five years the move in December was reversed in January when normal liquidity returned. Maybe the silly season isn’t quite as silly as it seems.




Joseph Trevisani
FX Solutions, LLC
Chief Market Analyst

Joe@fxsol.com



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