FX Weekly 05.02-05.09.08 - USD: Recession or Slowdown?

May 3, 2008

bkpicsmall FX Market Outlook
Dollar: Recession or Slowdown?
Euro: Topping Out
Yen: Risk is Back
Pound: Strength Against the Euro
Commdollars: Come Back

Top 5 Stories in FX This Week

Trading Lessons for a Lifetime
GDP in Charts
The World’s Most Valuable Digital Startups
What’s Behind the Slide in Gold and Silver?
Unstoppable Credit Contraction

—————–Trading Thoughts - Tightening the Noose—————–
For those who have followed us for a while you may have noticed something interesting over the past several weeks. We’ve been hitting the long ball. 3 out of last 4 trades resulted in triple digit gains. We made +211 on long AUDCAD +52 on short EURUSD +141 on short NZDUSD and +115 on long AUDJPY. What have we done differently to allow to bank such out-sized profits?

————–FX Market Outlook————–

“It shows that the argument about whether the U.S. is in deep recession or just a slowdown is being resolved in favor of the dollar bulls,” we told Reuters this week after the NFP printed a much better than expected -20K. Furthermore with Fed lowering rates only 25bp we noted that, “The long-term implication of such a shift in policy should favor the dollar, as markets begin to appreciate the fact that most of the monetary adjustment by the Fed has already been made.With most of the rate cuts behind us, the greenback, which has been battered relentlessly due to unfavorable interest rate differentials, may now find some reason to rally.”

Next week however, the focus will turn to the EZ as the monthly ECB conference takes place and traders will once again hang on to every word of Jean Claude Trichet. The Europeans are not expected to make any changes, but it will be interesting to see if President Trichet addresses the growing evidence of a slowdown in the EZ economy.

Rates will also be the focus in UK where the main question will be cut or no cut. Most analysts expect the BoE to stand down and that is in fact the most probable outcome given the modestly positive tone of recent data. On key cue will come from the manufacturing data on Wednesday. UK producers has been benefiting mightily from record low exchange rates against the euro and markets will want to see if this trend continues to translate into better than expected performance on the manufacturing front before putting on fresh GBP long positions.

Yen meanwhile nearly took out the 106 handle as risk returned in a big way. But the unit may have reached the near term limit of its rally which by the way corresponds (approximately) to 50% Fib retrace off the lows, if equities begin to slide back. Japan economic calendar is virtually non-existent next week so the pair should really trade almost exclusively off risk flows.

Finally the commdollars find themselves in a quandary. Commodity prices continue to skyrocket but traders fear a global slowdown. As we noted on Friday “If the bulls are indeed correct that the worst of the credit crunch crisis is behind us and global economy will continue to expand at 3% pace or better, Australia becomes the strongest beneficiary of such an outcome piggybacking on China’s voracious growth.

While RBA may have ended its rate hike cycle for now, it is unlikely to begin easing if economic conditions in Australia maintain their current levels. If RBA stands still, the Aussie with its 7.25% yield will remain a magnet for global investment flows and AUDUSD could hit parity if global risk environment remains benign.”

Meanwhile, Wednesday’s AUD employment data may be the key to further Aussie strength if it continues to surpass expectations.

————–Top 5 Stories in FX This Week—————-

Trading Lessons for a Lifetime
GDP in Charts
The World’s Most Valuable Digital Startups
What’s Behind the Slide in Gold and Silver?
Unstoppable Credit Contraction

Part of the reason is simply luck. We been very fortunate to make good selections that ran in our favor. But part of the recent success has also been skill. We’ve made two seemingly contradictory adjustments to our style that have resulted in much better gains. First we shortened our T1 target to 30 points and with exception of Friday’s extraordinary circumstances we left that target alone not touching the trade unless the target is hit. The idea here is to make sure that some profit is booked, so we are more than happy to give up 5 or 10 more points on the upside to assure us of a target.

Once T1 is achieved we move to break even and allow the trade marinate. Unlike many times before, we generally give it plenty of room to move about as we allow the market to build momentum in our direction. This relatively liberal approach to trade management keeps us in position as prices churn up and down and usually prevents any early stop outs unless the market moves all the way to our point of entry.

Once price makes a substantial move in our favor (+50 or +60) we start to move the stop on the 2nd unit albeit gently, still leaving plenty of room for a reasonable retrace. However, as price accelerates we become much more aggressive with our stops - a process we call “tightening the noose” which keeps a much tighter control on any slippage.

To sum up we are very laid back at the start of the trade, but make sure to bank some small profit right away and then become extremely cautious as price make a significant move in our favor. All of this correlates with our central tenet of trading which is to never let a winner turn into a loser.

Now let’s take a look at this week’s trades.