Season of Extremes - Coming to an End?
September 6, 2006

Abe Cofnas has spent over a decade as an equity broker, futures trader, and technical analysis instructor. Abe was one of the first professional trainers in the world to provide web-based interactive training exclusively on Forex trading. Since 2001, Abe's Forex Trader column in Futures Magazine has been a mainstay of the publication, providing innovative observations and educational tips on Forex trading to a world readership of over 65,000 traders.  You'll enjoy learning Forex from this master!

After several months of travel, FX training, and trading, I am pleased to be back with you! I'd like to share some thoughts about the current Forex market. 

The year 2006 is turning out to be a year of extremes in weather, geopolitics and in the Forex markets. The challenge for the Forex trader is to filter out the noise of current day events and seize opportunities for trading. Four currency pairs (the GBPJPY, EURCHF, NZDUSD, and NZDJPY) are at historical multi-year extremes. A closer look at some of them is worthwhile for gaining a better understanding of the dynamics of Forex trading.

The geometry of the GBPJPY crosspair price position has been truly amazing. Consider the yearly chart. We see that this pair is 250 pips from a key Resistance at 248 back in 1998. But a multiple time analysis shows the signature of an unsustainable momentum at these highs. The weekly patterns have been approaching a parabolic path. This is a classic portent of a reversal. If conditions emerge that will reduce carry-trade advantages, a strong and quick reversal is possible 

As I write this, economic data releases in Japan and Great Britain are showing surprise 
robustness in Japanese corporate capital spending and surprise weakness in British and Eurozone PMI surveys. Any economic data releases showing a weakening growth rate in Britain or a sustainable one in Japan can be the impetus to a significant retracement in the GBPJPY.

Let's consider the yearly patterns of the EURCHF which is another crosspair at an extreme. 

We see that this pair is at a key 32.8% Fib level from the 18234 high of Jan 93. From a technical point of view this alone provides us a solid alert for a reversal. To the 14443 low of Jan 02. The trend up from the lows is narrowing along with the compression in the pattern. The fundamentals also point to one as the Swiss economy compares well against the Eurozone. 

Let's consider the NZDJPY. The NZDJPY recently reached multi-decade Resistance levels. This pair offers the highest interest rate differential in the market. With NZD rates at 7.25% and JPY at 0.25% we can see the original logic of the strengthening NZD against the Yen. But the shape technically is looking exhausted.

These charts map the technical positions but they are reflecting some important fundamental forces affecting all three currency pairs. The GBPJPY has gained from a superior British economy and an uncertain Japanese recovery. The interest rate differential between these countries has been driving money flow into Britain. But any improvement in Japan can trigger a massive sell-off here if the carry-trade environment shifts. Any slowdown in British recovery can spark a major sell off of this pair. The EURCHF is at a key resistance reflecting superior economic growth in Switzerland. Finally, the Kiwi (New Zealands's Currency) is gaining strength with its very high interest rates at 7.25%. New Zealand's rates compared with Australia's 6% and the US's 5.25% have had the ability to increase the demand for the Kiwi and for its Uridashu bonds. The yield on the New Zealand 3year bonds are 1.76 more than the equivalent US notes. The NZDJPY pairs rise has been exactly in sync with the yield differential. However, New Zealand's central bank can't raise rates without a major recession risk and they can't cut rates due to inflation fears which already is at a 3.5% annualized rate. A slowdown can cause a major decline. 

While it is impossible to time a top exactly, these crosspairs offer technically a huge downside target of nearly 500 pip+ opportunities. While the charts imply large potential moves, the challenge for the Forex trader will be how to construct a tactical approach for entry, stop targets, or option instruments with recognition of risks. Nevertheless, these pairs demonstrate that a good understanding of the macro-economic forces shaping Forex prices is valuable. The extremes that we have seen are not simply technical extremes but reflect global growth, and interest rate differentials that are reaching the end of an historical season of extremes.