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Greetings From Singapore!
Hello there! It's been an "alphabet soup" week in this tiny but powerful Asian republic, with one appearance on the BBC, three on CNBC, and a speech before the local CFA organization. Let's get started!
The Definition of "Mixed Feelings"
Imagine that you are the CEO of one of the world's best-known financial juggernauts. As you take a break from an important conference, you smile as you notice that your company's stock is skyrocketing, climbing 8.5% for the day. Hooray! You dance for joy around your well-appointed office. Then it hits home; the stock is rising on speculation that you are about to be fired. Ouch! Don't feel too sorry for Merrill Lynch chairman and chief executive Stanley O'Neal, as his severance package is rumored to be worth $173 million.
Danger – Falling Shoes
Last week, Merrill Lynch reported $8.4 billion of write-downs on loans and mortgage-linked bonds, leading to the biggest quarterly loss of its 93-year history. This week, we will hear from European banking giants UBS, Deutsche Bank and Credit Suisse. UBS said at the beginning of the month it was writing down $3.43 billion, and Deutsche followed soon after, saying it would also write down over $3 billion in losses. Here's the kicker; on October 4, Merrill said it expected to write down about $4.5 billion in sub-prime losses. Just three weeks later, that figure has nearly doubled. If it turns out that UBS and Deutsche Bank have also grossly underestimated their losses, look out below; the proverbial "other shoe" that everyone keeps talking about may finally be about to drop.
Super Bubble
In last week's article, I wrote about a pre-emptive attempt by the Securities Exchange Board of India (SEBI) to pop an impending bubble in India's equity and currency markets. The SEBI announced that it was considering restricting the flow of investment capital from overseas, which has exploded this year. India's markets responded to that news with a fierce sell off. Well, the bubble doesn't want to pop! In fact, India's benchmark Sensex index reversed its losses and reached a new all-time closing high last week, in defiance of the SEBI comments. Now it appears as if the currency of India, the Rupee, is trying to reach new highs as well. After sliding back on the SEBI announcement, the INR is gaining steam vs. the USD once again (see figure 1)
Figure 1: After a brief break, USD resumes decline vs. INR. Source: Saxo Bank
Watch Out for the Yen
If subprime contagion and the credit crunch come back for Round Two, the most likely beneficiary will be the Japanese Yen. When fear gripped the financial markets in August, big players closed out carry trades, and the result was a huge short-covering rally in the JPY. This could be the play once again, as the Euro has gained over 1500 pips vs. the Yen since the August low (see figure 2).
Figure 2: Euro fell hard vs. JPY in August, now on the rise. Source: Saxo Bank
The Euro – To Infinity and Beyond!
After last week's debacle in the U.S. housing market, the U.S. Dollar sunk to new lows against the Euro and other major currencies. The weak market for existing homes is weighing heavily on the U.S. economy, and now a 25 basis point Fed rate cut on October 31 seems like a done deal. In fact, the Fed Funds Futures contracts, traded on the Chicago Board of Trade, or CBOT, now predict that the benchmark U.S. rate will fall to 4.00% by May of 2008. Since none of the other major world economies appear poised for a rate cut, I expect the greenback will continue to suffer until either the Fed indicates that it is finished trimming rates, or the other G7 economies begin to soften up. On a technical basis, we not only have a persistent uptrend in the Euro–U.S. Dollar (EUR-USD) currency pair, but we can see that the price has broken out of an ascending triangle within the uptrend. This foreshadows a further decline in the U.S. Dollar, as EUR-USD reaches the 1.44 handle for the first time since the inception of the Euro (see figure 3).
Figure 3: Ascending triangle breakout within EUR-USD uptrend. Source: Saxo Bank
Question of the Week
Q) Hi Ed, are there specialists or market makers in Forex like in the equities markets?
Ed Ponsi) Thank you for your question. The Forex landscape is a bit different from the equity markets; for example, every stock listed on the New York Stock Exchange (NYSE) has a specialist, who controls the activity in his or her allocated stock. The job of the specialist is to provide and maintain an orderly market; this is possible because all of the trades in that stock pass through one central location. However, many abuses do occur because of the great power wielded by these individuals and the seven firms that employ them, and the large sums of money involved. For example, in April of 2005, fifteen individual specialists representing five of the specialist firms faced federal indictments for fraudulent and improper trading. A specialist can cause a stock to rise and fall, and can cause the spread between the bid and ask prices to widen or narrow at will.
Like the NASDAQ, which also does not have one central location, the Forex market does not employ specialists. This makes for a much more democratic market system; it would be impossible for one person to control the activity in a currency pair, because Forex trades occur throughout the world, 24 hours per day. The NYSE's volume is dwarfed by the turnover of the currency markets, with the most recent estimates showing Forex volume at $3.2 trillion per day.
Like the NASDAQ, market makers dominate the Forex market. The main difference is that on the NASDAQ, the prices of multiple market makers can be viewed on a "level two" screen, while in the Forex market each individual market maker has their own platform. Will there ever be a level two-type trading environment for Forex traders? There are proposals that could be enacted before the end of this year to create a centrally cleared, global Forex platform that would include multiple market makers. Such attempts have failed in the past because not all of the major banks and market makers were willing to participate, but I firmly believe that in the near future we will see real level two-style trading on the Forex market.
The California Wildfires
After the devastation caused by last week's wildfires, our thoughts are with our friends in California. Irvine, CA, is the location of Online Trading Academy's headquarters, and the area is home to many of the company's members, instructors, and good friends. Our hearts go out to everyone who was affected by this tragedy, and we wish you well during this difficult time.
Have a question about Forex trading? Send an email to eponsi@tradingacademy.com and we may use your question in an upcoming newsletter. Until next time, best of luck to you in trading.
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Ed Ponsi is a globally recognized name as a lecturer and teacher and is the former Chief Trading Instructor for Forex Capital Markets. An experienced professional trader and money manager, Ed has advised hedge funds, institutional traders, and individuals of all levels of skill and experience. Ed has appeared on CNBC, CNN International and TheStreet.com, and has recently written his first book for Wiley Finance, "Forex Patterns and Probabilities" (which you can purchase through