A conversation between Greg Michalowski, Chief of Education at Forexlive, and Isabel Galera, co-founder and owner of Wordwide FX – Financial Translations. Part II: On the Markets
Isabel Galera: Let’s talk a little about the markets… I remember back in 2012 that the market was beating the EURUSD down. Everyone was tense and edgy. Do you have the same feeling now that the EUR and the USD are heading towards parity? It seems to me that everyone is good with that, since the depreciation will help exports in Europe. Am I wrong or…?
Greg Michalowski: The currency mechanism caused by free floating exchange rates allows for the weak to get stronger and the strong to get weaker. Thankfully for traders who are focused on attacking trends, and for the EU as well, the US has been on a steady recover over the last few years. It may not be great from historical standards, but on a comparative basis to Europe, the US economy has seen stronger employment and GDP. This has allowed for the EURUSD to finally move lower. – especially post-ECB QE and post-US QE taper.
However, as the weak get stronger from the benefits of a weaker currency and the strong get weaker from a stronger currency – all things being equal – the tide can turn.
With the EURUSD moving from 1.3800 to 1.0500 in the last year or so, that is a 23% benefit to European exporters and a 23% hardship for American multinationals. From the European side, if that move does not help Europe economy, and get it off its back, then there are structural competitive issues that will need to be addressed and solved from the EU side. For example, in a technology world, can Italy or Greece compete vs. the US at any exchange rate? Maybe not.
Putting that aside, at some point, there is line that is crossed whereby the US starts to slow because of the US dollars appreciation. Although it may seem that Europe would be happy to have the EURUSD not only go to parity but all the way down to 0.8500, that move does come at a cost. For example, if the US stock market crashes and the US enters a recession that may not be so good – even if the EU should benefit competitively from a lower Euro. Remember, the US has to buy your goods in order to benefit. If they don’t – because they enter a recession – all ships can sink at the same time.
So my guess is most of the work has been done. Now it is a balancing act to see if the EU recovers, the US stays steady, and all boats are lifted instead of sinking.
IG: How is the downfall affecting other European currencies like the GBP or the CHF?
GM: The EURGBP and the EURCHF have of course moved lower. In addition to general EURO weakness, the EURCHF had the de-pegging which added another layer of volatility and currency adjustment for that pair.
Fundamentally, because of proximity to EU nations, and the fact each are smaller economies (compared to the US) the impact from the Euro’s tumble can lead to hardships that the US might be able to get over.
In Switzerland, the SNB de-pegging in January and subsequent plunge is still a work in progress with the implications still a mystery, but the bright spot, is it could have been worse for them. Nevertheless, it now opens up the prospects for a higher CHF from safe haven flows should the EU falter, stock markets plunge or other geopolitical reason. It also can be a real problem for the Swiss export economy and deflationary prospects in Switzerland. If that happens, the EURCHF should rise (CHF depreciate), but that “safe haven” status could keep the CHF from depreciating. That might lead the SNB to lower rates to even more negative levels or intervene. I do not expect them to re-peg though.
I think the EURCHF will probably trade 0.9900 to 1.0900 for the rest of the year.
For the UK, the country has weathered most of the storm from the Euro area. Until recently, it was thought the BOE would also tighten in 2015. That picture has changed, however, and we are seeing a little more weakness in the GBP vs the EUR and the USD as well.
The May election will likely create havoc for the GBP in the short term. I go back to the Scotland referendum where the market sold off the GBPUSD, rallied on the day and sold off from there. That was in the low to mid 1.600’s. We are below 1.5000 now. So maybe we sell off, then rally afterwards. For the EURGBP, 0.7550 should cap things. The recent low at 0.7000 area was a nice low too. That is my best guess for the wide range.
IG: A strong currency is not always an indicator of a strong economy. I’m thinking, the EUR has been one of the strongest currencies in the last years but the Eurozone economy has been pretty wobbly. How do we account for that?
GM: It takes two to tango (or to move a currency), and at times “the market” traders and central bankers also get it wrong.
Remember, there were times in the last few years, when the US was the laughing stock of the world as a result of government shutdowns due to budgetary problems and debt ceiling limits. So politics was an issue and the dollar was sold off on the back of that debacle.
Also although US employment was coming down, there were always other concerns about the employment picture that kept the Fed’s pedal to the metal with regard to QE and the Fed rhetoric more dovish. Higher oil prices also kept the dollar weak in the past. Not anymore.
In the EU, the ECB was not engaging in QE. That was bullish for the EU. Also Draghi at times talked the EURO up, kept rate higher and pretended to see/ hope for a recovery. Whereas, the Fed was more dovish, the ECB was more hawkish.
In hindsight, perhaps the ECB and the Fed should switch their speeches.
Anyway, those things helped contribute to the market getting it wrong. Ultimately, it did not help the EU economy get on a road to recovery. For the US, it might have helped it recover more quickly, however.
IG: The USD is gaining strength every day against most currencies. I remember a few years ago, no one seemed to like a strong dollar. Do you think “the market” will “talk it down”, so to say?
GM: The data and the earnings from multinationals will determine the dollars fate. Can US companies afford more dollar strength? One can argue they can if domestic demand and employment stays strong, the dollar can rise. Domestic demand can do wonders – especially when consumption is 2/3rds of US GDP.
If domestic consumption can keep growth at 2.4-3.3% growth, that will be the best case scenario for the EU as well.
However, if that line in the sand is crossed and US employment growth slows and, domestic consumption slows, the dollar strength could correct or slow. I don’t expect the EURUSD going back to the high for the year from January 2 at 1.2100 area, but can it trade 1.1200-1.1300? Maybe.
IG: One more question, Greg… We started 2015 with the belated “Christmas present” from the SNB, and there are so many things going on in the markets… Do you think volatility has decreased to a point where it’s less risky to invest in FX?
GM: There will always be risk in the markets – even in currency pairs that are “pegged”. Pegged can become de-pegged and cause all sorts of problems as we experienced with the SNB decision.
Some people think the EURUSDs move from 1.2100 to 1.0500 was “volatile”. I don’t. I see that as a trend. Trends tend to be fast, directional and go larger trading ranges. Is that volatile? No. I look at it as a period where traders can make the most money with the least risk. All you have to do is get and stay on the trend, and you make money fast with little risk.
Conversely, if you are not attacking the trend, you are in trouble. You lose money fast and with lots of risk to your capital. Whose fault is that? Most traders who lose will blame the volatility of the FX market. In reality it was the traders own stubbornness and inability to recognize that trends are fast, directional and go farther than anyone thinks.
To me, volatility is when the market goes up one day, down another, up and down and up again in the same day. That is volatile to me. That type of market is the most risky for me simply because I expect sellers who pushed the price lower, to sell again when the price corrects 38.2-50%. Logic says to me that traders – who sold 4 hours ago on the break of 1.0800 – would be happy to sell again when it corrects 40% into that area. How can you not like selling again?
When it does not find the seller at 1.8000 and instead moves the other way up to 1.0860 (with no news), that means the story changed from bearish to bullish – just because. That type of market volatility is “more risky” to me. You can die from a thousand superficial knife wounds from that type of “volatile” market action. It is like being in a bar fight. There are few winners in an all-out brawl in a bar. One broken glass in the hands of a crazy small guy, can stop the biggest and strongest guy. Random.
Last summer when the World Cup was going on, and traders were also on vacation mode, people said the market was “less volatile”. Did anyone make money then? No. It was randomness of the volatile up and down action.
In September when the market trended, those who got killed from the “volatility” of the trend, really died from a self-inflicted stab wound. It was not “the markets” fault or because of volatility (i.e., a large directional and fast move). It was a trend and they traded against the trend.
So if we repeat World Cup 2014 in 2015, I will be sitting on the sidelines mostly watching the bar fight play out and waiting for the next trend.