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Coincidence? I Think Not
Hello from Singapore, the Lion City! As usual, things are happening here – the town is abuzz over the official opening last week of the Singapore Flyer, billed as the world's largest observation wheel. In addition, the first ever Formula One night race will be held here this summer. Perhaps you caught me last Tuesday guest hosting CNBC Asia's flagship program, Squawk Box. I'll be guest hosting the show again this Friday.
Into The Future
One could say that a futures contract predicts the likelihood of a future event. The price of a futures contract is created by traders who will be rewarded by turning a profit if they are correct and will be punished with the loss of money if they are wrong. Therefore, we can say that the price of a contract, which represents the opinion of the market, is more valuable than the opinion of any individual analyst or trader. A good example of this is the Fed Funds Futures contract, which trades on the CBOT (the Chicago Board of Trade, which merged with the Chicago Mercantile Exchange last year). This contract currently predicts that the U.S. Fed Funds rate, currently standing at 2.25%, will fall to 2% after next week's FOMC (Federal Open Market Committee) meeting. The likelihood exists for further rate cuts beyond next week, but the contracts seem to be saying that this cycle of rate cuts will end sooner rather than later.
Perhaps if these future traders believe that Bernanke and the Fed are nearly finished cutting rates, the U.S. Dollar will finally find some support. The greenback's dizzying decline has been a topic in this column since its inception, but the damage to the U.S. currency has accelerated in recent months. The Euro has made an incredible run, racing from 1.45 to 1.59 vs. the U.S. Dollar since early February, as seen here on the daily chart (see Figure 1).
Figure 1: EUR/USD has rallied 1400 pips since early February. Source: Saxo Bank
If you caught my appearance on the BBC last Friday, you heard my prediction that after a period of consolidating its recent gains, the EUR/USD currency pair will continue to rise, possibly to 1.70 by year's end. If that sounds farfetched, consider this: while a rise to 1.70 from the current 1.59 would require a gain of 1100 pips, or 11 cents, Euro has already gained 1400 pips (14 cents) vs. the greenback in the past 2 ½ months, and has climbed a whopping 2600 pips (26 cents) since August of 2007, as seen here on the weekly chart (see figure 2).
Figure 2: Weekly chart shows EUR/USD climbed from 1.33 in August 2007. Source: Saxo Bank
Kudos to the BBC interviewer for remembering that on my previous visit last fall, I predicted that EUR/USD would rise to 1.60. At the time this sounded pretty outrageous, since the pair was trading around 1.40 last fall, but it sure doesn't sound farfetched now. EUR/USD touched 1.5980 last week, a mere 20 pips from 1.60, before pulling back slightly to its current level near 1.59.
Hunger Strike
Singapore is allowing its currency to strengthen gradually vs. the U.S. Dollar, in a bid to stave off the inflation that is rampaging through economies here, driving up food prices and creating a dangerous situation for the many who live on the brink of starvation. The greatest risk belongs to those countries who are dependent on food imports.
Just yesterday in West Bengal, workers and students held a strike to protest rising food prices; a similar strike occurred in India's fourth largest city, Kolkata. In Mexico there is a saying, "when the tortilla rises, the government falls," and some analysts are predicting a crisis in that country. In Thailand, nearly half of the respondents of a survey said they are cutting back on rice, which is ironic because that country is the world's largest producer of rice. According to an official of the Asian Development Bank, "The era of cheap food is over."
Who is to blame for this problem? The media seems focused on biofuels as a cause, because grain harvests are being diverted to gas tanks instead of dinner plates. But this is not the entire answer. Because some people are panicking and hoarding food, supplies are scarcer than they should be. Speculators are jumping on the bandwagon, driving prices higher. High oil prices make it more expensive to harvest the crops and ship the products, and these expenses are passed on to the consumer.
Unintended Consequences
One thing is for certain; the current low-interest rate environment is not helping the situation. Central banks fight inflation by raising interest rates. Meanwhile, the Federal Reserve, the Bank of England, and other central banks have been cutting rates and adding liquidity in a bid to prevent a recession and the collapse of major financial institutions. The Fed is particularly culpable, because Ben Bernanke and company have cut rates by 300 basis points over a relatively short period of time. This has caused tremendous inflation in the U.S., arguably much higher than the reported inflation rate. Now consider that many countries have tied their currency to the greenback, meaning that they are also importing inflation along with the U.S. This inflation is having a ripple effect throughout the world.
I would argue that over the past decade, every time the Fed either pumps up liquidity or goes on a rate-cutting binge, they are unintentionally creating a bubble. Right now they are doing both. Remember Y2K? The Fed pumped the system full of money in 1999 because they were afraid that a computer design glitch would plunge the world into chaos when the new century began. So where did the money go? Much of it was funneled into the Nasdaq, creating a spectacular tech stock bubble as the index eventually climbed above 5000, more than twice its current value today, eight years later.
After the tech bubble crashed, the U.S. entered a recession. In order to create growth for an economic recovery, the Fed under Alan Greenspan cut interest rates to 1.00%. The unintended consequence this time was the housing bubble, as real estate prices in the U.S. and elsewhere skyrocketed to unbelievable heights due to low mortgage costs, along with a hefty dose of unscrupulous lending. Now that the housing bubble has crashed, the Fed is once again on a mission to provide money at low rates. Simultaneously, we are seeing the creation of a third bubble, this time in the prices of commodities like oil, gold, and most importantly, food.
Coincidence? I think not. Perhaps it is time for the Fed to realize that we can't solve our problems by just throwing money at them. Instead, we just end up with bigger problems. Cutting rates and adding liquidity is fine, but doing it in drastic fashion creates unintended consequences.
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