Beware of Seasonal Forex Reversals

by Ashraf Laidi
Nov 19, 2008 22:40 | 13 Comments

Although currencies ended up adopting their usual path of following the swings in risk appetite, it's worth explaining Wednesday's earlier spikes in EURUSD and GBPUSD. The moves were a result of broad dollar selling (also seen in a $25 rally jump in gold) on reports that Iran was pushing ahead with its nuclear program. The International Atomic Energy Agency found stated an increasing build up of enriched uranium stockpiles, which could be converted into weapons-grade material. Despite the Iran element of the dollar decline, caution is urged of renewed selling waves in the greenback vs. all majors except the yen as seasonal reversals in FX markets usually emerge in the last 5-6 weeks of the year, paring the flows prevailing in Sep-Oct. These reversals emerge from end-of-year position squaring, with dealing desks functioning on skeleton staffs. The chart below illustrates this phenomenon for EURUSD over the last 3 years. A repeat of these trends could see reversals in EURUSD, GBPUSD and USDJPY towards $1.33, $1.62 and 100.00.

Beware of Seasonal Forex Reversals - Eurnov08 (Chart 1)

One reason, however, that 2008 might prove an exception to these reversals would be for bank dealing desks to add in more hours than is usually the case in year-end in order to maximize trading revenues and ease the operating losses posted throughout the year. And as long as the laws of risk appetite continue to dictate Forex flows, proprietary desks will have no choice but to pursue lower yielding currencies, especially as stocks are resolved to retest the lows of October 2002.

FX Flows Remain Enslaved to Risk Swings

Despite GBPUSDs surge past the $1.5090 resistance onto a 1-week high of $1.52, I warned (CMC clients) that "caution is urged due to GBPUSD's knack for notorious pullbacks at the end of the London session". Ultimately, cable peaked out at $1.5245 before tumbling 300 points as risk aversion soared amid the 6% tumble in US stocks. Remarks from Bank of England's John Gieve indicating prolonged rate cuts due to the possibility of inflation falling below the 2.0% target in 2009 (from current 4.5%). Recipients of the IntradayThoughts were informed that $1.5275 would remain intact as it presented the trend line extending from the Nov 3 high. Similarly, EURUSD gave in at the trend line resistance of $1.2780 (4-hour chart) extending from the Nov 10-13 highs.

Falling inflation and contracting home building remains the hallmark of the current economic landscape as US CPI tumbled 1.0% in October (biggest on record) exceeding expectations of a 0.8% decline, while core CPI fell 0.1% vs. forecasts of a 0.1% increase. Year-on-year figures show a 3.7% increase in the headline and 2.2% in the core. October housing starts up 791K, building permits at 708K. Although the deepening price erosion in all inflation indicators could be perceived as a positive for US stocks on the basis of prolonged Fed easing, the negative impact on profit margins remain considerable, as pricing power disappears in an already poor demand environment. Adding the element of weak foreign demand and the negative impact of currency translation from lower non-USD currencies, US multinationals are set for a multi-dimensional earnings slump, thereby, adding to the fundamental argument of the equity selling.

Feds Forecasts Chase Reality

In stark illustration of another central bank outlook falling behind the real economy, the FOMC downgraded its economic projections for 2009 and 2010 from those made in June. The range of forecasts for 2009 GDP growth was lowered to -0.2% -1.1% from Junes 2.0-2.8%, core PCE was lowered to 1.5-2.0% from 2.0-2.3%, while the unemployment rate was revised to 7.1-7.6% from 5.3%-5.8%. The Fed's continued downgrades of the economy not only show the central banks miscalculation of the real economic risks to the economy, but once again underestimate their assessment ahead. The unemployment rate for instance is widely expected by private economists to reach 8% in 2009, a figure that isnt even included in the higher end of its forecasts. The forecasts highlight the increasing probability the Fed funds rate could reach 0% before end of Q1, a possibility already echoed by San Francisco Feds Yellen. But at least the Feds excessive preoccupation on inflation is diminishing markedly. The latest projections noted "The majority of participants judged the risks to the inflation outlook as roughly balanced, and a number of others viewed these risks as skewed to the downside--a marked shift from June, when the risks to inflation were generally seen as tilted to the upside".

The latest study from the World Gold Council showed an 18% increase in Q3 demand due to safe haven flows resulting mostly from financial market turbulence. Investment demand showed solid support from ETFs, jewelers demand advanced on falling prices, while industrial demand fell on broadening economic slowdown. Golds decline relative to most currencies has been primarily a function of the rising dollar emerging from the globalized nature of the economic slowdown and the massive liquidation in dollar shorts of the first half of the year. This point was especially highlighted by the $100 spike on September 17th when Lehman Bros failure and AIGs woes were considered a largely US-centric risk. Nonetheless, during the past month, gold continues to outperform oil prices, consolidating around the $740s is seen as a prime candidate for rallying on the earliest signs of stabilizing risk appetite and nascent signs of a recovery in Europe and the US.

Comments (Showing latest 10 of 13) View All Comments
Ashraf Laidi
London, UK
Posts: 0
11 years ago
Nov 27, 2008 9:07
Mamood,

Good point ! I am more certain that the role of seasonal reversal will be effective in favoring EUR, GBP, CAD against USD than weigh on JPY vs USD.

USDJPY seems unusually FROZEN at 95.00-95.80 (take a look at the 2-hour Williams % R and Bollinger Bands) because it is torn between improving markets (good for USDJPY) and geopol risk and continued econ weakness (bad for USDJPY).

You can use hedging in JPY trading, whereby go long EURJPY and short GBPY.

Ashraf
Mamood
Vancouver, Canada
Posted Anonymously
11 years ago
Nov 27, 2008 6:23
Ashraf, is your statement below still valid about reversal especially for USDJPY? Your comment on CNBC did not appear that way.

"A repeat of these trends could see reversals in EURUSD, GBPUSD and USDJPY towards $1.33, $1.62 and 100.00."

Thanks,
Mamood
Ashraf Laidi
London, UK
Posts: 0
11 years ago
Nov 24, 2008 20:51
Tracy,

As these seasonal reversals get underway, both gold and CAD go up, which means GOLD is likely to breach above the 100-day moving average of 832 and USDCAD drops towards 1.2120. This is especially the case that CAD is a commodity currency, thus, you could see Aussie, CAD and NZD rsie along with gold and oil. But gold remains my preferred commodity relative to oil, as we should see $1200 before Q3 2009.

Ashraf
Tracy
United States
Posted Anonymously
11 years ago
Nov 24, 2008 19:22
Hello Ashraf,

Really like your site...you mentioned gold breaching the $810 resistance level my question is how does gold's ris interrelate to the seasonal FX reversal and the USD/CAD?

Thanks,

Tracy
Ashraf Laidi
London, UK
Posts: 0
11 years ago
Nov 23, 2008 23:36
Frank,

Normally, continued selling in US and world equities should continue to favor the yen as the best currency, followed by the dollar at the expense of EUR, AUD, NZD, GBP etcc. BUT BE CAREFUL about the catalyst to renewed selling in equities. if the catalyst is largely US-based, e.g. Citigroup, then that may be bad news for the dollar across the board, benefiting gold. This was seen in mid September when Lehman went bust and AIG was feared to go the same road. I wrote about this in my last article in the gold section.

Also, for those betting on prolonged risk aversion (falling equities, rising JPY and USD) must be warned due to the possibility of a year-end rally, which could emerge from news of a bailout package for US autos, Citigroup breaking up etcc.

Ashraf
Frank
Vancouver, Canada
Posted Anonymously
11 years ago
Nov 23, 2008 5:31
Ashraf ,, what if we get another 20-30% sell off in the stock market because of a Citigroup bankruptcy or something .. Would the US $ and yen just keep raising or at some point in a stock market sell off would they start selling off with the stock market ? At what point would the US $ and Yen be to high under these cirumstances ?


Cheers

Frank
Ashraf Laidi
London, UK
Posts: 0
11 years ago
Nov 21, 2008 7:11
Bubbles,

In case you still have problems getting the book from Amazon, you can try Barnes&Noble. http://search.barnesandnoble.com/Currency-Trading-and-Intermarket-Analysis/Ashraf-Laidi/e/9780470226230
Ashraf Laidi
London, UK
Posts: 0
11 years ago
Nov 20, 2008 17:43
New,

Gold and dollar feed off each other. My medium and long term assessment for gold remains positive. Once stocks mount a rebound, dollar eases off and gold rallies, especially amid the first signs of economic stability in China, Canada and Australia.
New
qingdao, China
Posted Anonymously
11 years ago
Nov 20, 2008 14:06
Ashraf,thank you for this insightful article.
I found gold price is hard to analyze from a fundamental perspective,is the primary determinants are us dollar trend and inflation perspect?what is your view about the long term and medie term trend of gold?
Ashraf Laidi
London, UK
Posts: 0
11 years ago
Nov 20, 2008 8:00
Hamish, if this reversal takes place, USDCHF may have to pull back towards 1.15. get set for a nasty European open. And watch the support of those triangles in the weekly JPY pairs.

Ashraf