Wednesday September 8, 2004 - 20:28:53 GMT
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Forex: Broad Equilibrium Makes For Tough Trading
Broad Equilibrium Makes For Tough Trading
It is no mystery that fund managers do well trading markets that trend toward large over and under shoots, and normally when there are macro conditions far out of alignment. Simply put, the world economy from G10 to "liquid" emerging markets is doing just fine. Inflation is low albeit rising mostly, monetary policy for the most part is appropriate and growth is positive if uneven. Emerging markets are by and large performing well (exception of course are the HIPC). Absent are unsustainable currency regimes of the 1990's. Monetary policies have exerted a sufficient degree of independence and determination to restore confidence in local currencies. Spreads above US Treasuries are low. Fiscal deficits remain a weak point globally with a few exceptions (Canada for one). But this phenomenon is self-canceling...does not really favor one country (currency) over another. Not even the yuan peg is a source of major speculation and has not been for months as China has moved to rein in growth and avoid overheating with controls over lending and speculative real estate development. In other words there is no glaring weak spot for fund managers to exploit in any sustained way.
Yet funds are paid to trade and post profits. Surely this equilibrium condition has forced funds to narrow the time horizon on trades generally. But trade they must and when there are no major pressure points to press, funds are forced to exploit near-term events and data (something that always happens but now is intensified given the absence of major trend trades). Hence scenes like today's reaction to Greenspan's testimony seem to be more the rule than the exception. The event to exploit was a hawkish testimony and hence be short bonds/eurodollars, long dollars and long stocks. The trade, with hindsight, proved crowded and few could stay with it when it was clear from early on as the prepared text hit the wires that the testimony was a bit understated on the hawkishness scale for Greenspan. Indeed the dollar reversed all of the gains it made Friday after BLS reported non-farm payrolls rose 144,000 in August.
But all is not lost for the buy and sell side eager to see a market driven by important misalignments. This equilibrium is not likely to be long-lived, though surely some officials and market participants would argue otherwise. What can upset the equilibrium? Oil...another sustained move up in price. Terrorist attack. US current account funding problem. Property market bubbles bursting in key economy like UK, Australia or the US. Collapse in US consumer spending behind high debt and desire to boost savings for retirement. Or something we do not foresee...global pandemic for instance (not fear mongering here...ask WHO). In other words the current global balance is a temporary equilibrium. Trend trading on
fundamentals will come back. When? Not sure this can be answered. But there are enough risks hanging around to suggest sooner than later (still think US slowdown is more than a patch).
In the meantime it makes sense to look for ranges, avoid crowded trades or exploit crowded trades...apply pressure to trades where risk aversion is high. And be conservative on when the next big macro trade emerges...don't need to be in early otherwise risk selling bottoms and buying tops.
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