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State of Trading 4 November 2008: National economies around the world have been hit hard by the credit crunch. As these financial markets thaw, with risk acceptance returning to the forex trading market, and as currencies resume answering to economic fundamentals rather than fear and greed, here are some trading perspectives to consider.

According to the classical definition of a recession—two consecutive quarters of negative GDP growth—many of the world’s developed economies are currently entering that phase of the economic cycle. New Zealand is already there although as yet the shrinkage is mild. The U.S., U.K., Japan, and the Eurozone have the first negative quarter behind them and no one doubts the second one (and possibly more) will follow.

This global recession will cut into commodities purchases, lowering the prospects for those nations dependant upon such exports for a significant portion of their GDP, including Australia, New Zealand, and Canada. At the same time, nations which depend more upon the export of machinery and finished goods, such as Japan, the U.S., and the Eurozone, will find fewer overseas customers for such capital purchases. As for emerging economies, the decoupling theory has been well and truly put to rest and there is no doubt these nations will be hurt by the slowdown although perhaps not as drastically as in previous recessions.

The direct result of this global slowdown, and the most important one for forex traders, will be lowered interest rates from many central banks. As large institutions such as hedge funds often trade the interest rate differentials between nations, these shifting balances will move the markets as currencies and investors both seek a new risk-reward tradeoff.

The U.S. dollar’s long slide, particularly against the Euro, in 2007 and the first half of 2008 was fueled by fundamental data showing the U.S. economy was not performing as strongly as the economies of other nations around the world. With the slowdown stretching globally this will no longer be the case.

Another cause of the USD’s decline was the FOMC’s aggressive interest rate slashing, one of several policies initiated to prevent the U.S. financial system’s collapse. This increased the rate differential between the U.S. and many other nations, especially emerging economies and the commodities exporters such as Australia and New Zealand, and this was a major cause of AUD/USD rising as high as 0.9848. Again, as economies in other nations slow, as interest rates are reduced, and as the rate differential shrinks, USD stands to maintain its current gains and also appreciate against the Japanese yen.

Of course, any analysis of forex trading going forward is very much dependent upon the future stability of financial markets. Another blow to investor confidence, the formation of another bubble in commodities or a particular category of stocks, or another major financial institution under siege could easily wipe out any advances made in LIBOR and the TED spread and return equities and financial markets to the starting point of Black October 2008. Such a scenario would see JPY and USD appreciate further on renewed risk aversion.

In either scenario, there may not be such strong trends as the forex market has seen recently. But there are always pips to be traded.

Week ending 31 October 2008

Halloween can hold no terrors for survivors of October 2008. Credit markets continued to thaw, while equities and other markets emerge from arguably the worst month in financial history. Central banks around the world continue slashing rates as the global slowdown intensifies, with only forex trading remaining potentially profitable.

The RBA meets 4 November and is widely expected to cut rates by 50bps (possibly more) to 5.5%. In a light data week, private credit grew by 0.7% in September, more than forecast but below trend. AUD/USD lost 15% in October and appears to be settling into a range between 0.7050 and 0.6000, closing the week at 0.6643 on high volume.

As expected, the FOMC cut rates by 50bps to 1.0% and U.S. 3Q2008 GDP printed negative at −0.3%, with personal consumption for the quarter down −3.1%. In September data, personal income rose 0.2% while personal spending shrank −0.3% as consumers retrench and deleverage beside financial institutions. Durable goods orders rose 0.8% after August’s −5.5% collapse, new home sales rose 2.7% m/m, and the October Richmond Fed Manufacturing Index fell to −26 from −18.

The ECB meets 6 November and is expected to cut rates an additional 25–50bps despite the October coordinated central bank action. September unemployment held at 7.5% while October CPI lowered to 3.2% y/y, and PMI fell into recessionary levels at 44.3. EUR/USD rebounded to 1.3296 on 30 October, completing 61.8% on a potential Fibonacci retracement from 14 October’s high of 1.3769 and 28 October’s low of 1.2329, best seen on four-hour charts; however, the week’s close at 1.2742 is also the 61.8% on another potential retracement between the 28 October low at 1.2329 and the 30 October high at 1.3296. Ongoing market volatility, risk aversion, and the ECB decision holds the key as to next week’s trading.

The BoE meets 6 November and is also likely to cut rates an additional 50bps. Nationwide House prices registered a fall of -1.4% m/m in October for a cumulative y/y loss of -14.6%. GBP/USD poses the same double-edged Fibonacci query, between 20 October’s high at 1.7516 and 24 October’s low at 1.5265 with 30 October’s high at 1.6672 reaching the 61.8% level, and this week’s close at 1.6092 reaching the 38.2% retracement from 24 October’s low at 1.5265 and 30 October’s high at 1.6672, again best seen on four-hour charts. EUR/GBP declined steadily through the week to close at 0.7917, the epicentre of the range it has held since mid-March.

Canadian August GDP printed at −0.3% m/m, slightly beating market expectation, while PPI for September fell −7.2%. USD/CAD rose 11% in October, closing at 1.2053 after spiking to 1.3016 and bouncing from support at 1.1900, while on four-hour charts AUD/CAD is respecting resistance on the 200-period moving average, attempting to find a range between 0.7750 and 0.8450.

New Zealand posted a September trade deficit of NZ$1183.0Mn, double market expectation. NZD/USD continued its general downtrend, closing at 0.5820, and AUD/NZD remained rangebound between 1.0900 and 1.1420, with a brief push upwards to 1.1600.

In a surprise move, the BoJ cut rates by 20bps to 0.3%. CPI for September rose 2.1% y/y, while retail trade fell −0.4% y/y. September industrial production rebounded 1.2% m/m and 0.4% y/y from −6.9% y/y previous. The unemployment rate fell to 4.0%, and September household spending fell to −2.3% y/y. USD/JPY remained below 100.00 for the week, while AUD/JPY lost 21% on carry-trade unwinding in October, closing at 65.43.