The Big Picture: A Slowing Global Economy and Risk off to Accelerate
In terms of the markets, we have a global economy slowing and that slow up is accelerating and the global economy will not return to growth anytime soon. Central banks that have no tools left to create growth while at the same time, stocks are at bubble levels and Government and private debt are record highs. Trade wars are not likely to be solved soon with both the US and China unwilling to back down but even if they were it wouldn't help kickstart growth in the global economy why?
Because the trade between the US and China which is impacted by tariffs is minor in the overall global picture - The China slow up cannot be reversed and most other major nations are seeing growth slow up: from South Korea to Eurozone to the US. Against this backdrop, safe currencies should appreciate on risk currencies moving forward and if we do get a crash or serious correction they will soar higher.
The strategy is to simply buy currencies which are in a group higher than the next when the right technical set up presents itself - this strategy has done well in the last few months and more details about how we select the best currencies to trade and shift allocations are outlined below in a brief overview after a review of the currencies in the four groups.
Note: Before the 2008 crash it was group 4 currencies that started to sell off hard which warned of a crash coming and the same is happening again and a meltdown in the emerging currencies could occur at any time due to their high debt levels and they need for the global economy to expand to remain stable - we don't see anything other than more downside longer term. They are lesser looked at pairs but only need small positions to make great profits against the risk taken. In the majors, the commodity currencies also have a long way to go the downside and offer good risk to reward - they have made us great profits already and we see more downside.
Summary of groups below and some notes on how we are trading them at the end of summary:
Forex Pairs 4 Groups from Safest to Weakest
Below are four groups in terms of safe to risky. It's just a general guide but when were trading it's normally a safe over a risk currency if we are taking any long term position trades.
Group 1: Safe Haven Currencies
Japanese Yen: Considered the world's number 1 safe-haven currency so why is a country that has high debt levels low-interest rates and low economic growth considered a safe haven?
Japan has always been a large exporter and has continually exported significantly more goods and services than it imports. The result has been decades of current account surpluses that have positioned Japan as a net creditor to the world.
In addition: The value of foreign assets held by Japanese investors is substantially higher than the value of Japanese assets owned by foreign investors. These so-called “net foreign assets” stood at 450 trillion yen at the end of 2018, based on data from the Finance Ministry. This places Japan as the largest creditor nation, a title it’s held for the last 25 years.
Japan has also the second-largest bond market in the world. In times of economic stress money will flow into bonds and away from riskier assets such stocks etc
US Dollar: The world's biggest economy and it's the Second save haven by default due to its status as Global Reserve Currency. Almost 40 per cent of the world's debt is issued in dollars. As a result, foreign banks issue a major proportion of their loans in currencies that are not their base currency. For example, the banks of the UK Euro Zone and Japan have a higher percentage of USD loans than they do in their base currency:
Note: In times of economic expansion there are a high number of USD loans granted which pressures the USD but in times of contraction new loans drop, existing loans are not rolled over or recalled which pushes the USD higher.
One-third of the world's gross domestic product comes from countries that peg their currencies to the dollar. That includes seven countries that have adopted the U.S. Around $580 billion in U.S. bills are used outside the country. That's 65 per cent of all dollars. In 2019, it makes up nearly 65 per cent of all known central bank foreign exchange reserves.
The US is the only one of the 3 safe havens to run a current account deficit but this is offset by its global reserve status. Also, the US is the most insular major economy with the consumer in the US accounting for 70% of GDP which is more than any other nation.
Swiss Franc: The Swiss franc gains strength like the JPY from Switzerland's current account surplus of exporting significantly more goods and services than it imports. Another factor is the country’s relatively low level of the national debt. While most of the world’s top 10 economies have debt ratios of around 100% (or more), Switzerland’s is less than 30%.
The Swiss Franc is also a safe haven based upon Switzerland's neutrality over the years and stable banking system. Despite being many crises that have hit the world’s financial markets, Switzerland has always been a country which has had no problems with financial institutions going down.
Group 2: Developed Stable Economies
The Euro: The eurozone runs a current account surplus and also has the third-largest bond market in the world which is nearly the size of Japan's.
British Pound: A safe stable country with a liquid bond market.
Singapore Dollar: Singapore, while exposed to many emerging markets, benefits from being the only Southeast Asian country considered a developed, rather than an emerging, market as well as from a triple-A rating on its debt and also has a current account surplus.
Group 3: Commodity Currencies and Euro Proxies
Australian Dollar: Australia's Major export market China. Major commodities exported and to watch: Mineral fuels US$87.7 billion (34.6% of total exports) Ores, slag, ash: $59.7 billion (23.5%)
New Zealand Dollar: Major export market China. Major commodities exported and to watch: Dairy: US$10.2 billion (26.5% of total exports) Meat: $5.2 billion (13.5%)
Canadian Dollar: The major export market is the USA. Main exports are Mineral fuels including oil: US$99.3 billion (22% of total exports) Gems, precious metals: $18.3 billion (4.1%) Wood: $14.3 billion (3.2%) The strongest of the commodity currencies in risk-off due to commodities are a smaller percentage of GDP than either Australia, New Zealand and Norway.
Note: Out of the 3 commodity currencies the CAD is clearly ther stronger longer-term and being long CAD V NZD AUD has been one of our favourite position trades several months and any rallies in AUD/CAD NZD/CAD are long term selling opportunities.
Norwegian Krona: Norway is rich, has a current account surplus and is seen as stable but is heavily dependant on crude oil being Europe's largest oil exporter. Norway is in the global top 5 exporters of crude oil. The oil and gas sector constitutes around 22% of Norwegian GDP and 67% of Norwegian exports.
Danish Krona: The Most correlated currency with the euro due to it being pegged to it by its central bank within narrow bands.
Swedish Krona: Sweden is seen as a safe and stable democracy but has major problems in terms of economy in terms of work worker productivity is low and the economy has a huge social welfare burden. The economy is heavily exposed to the eurozone as a trading partner.
Czech Krona, Polish Zloty and Hungarian Forint
These 3 currencies all have the same personality and while their commodity currencies they can also be termed emerging market economies as well. All 3 countries are heavily dependent on exports with between 70 – 80% of goods and services in the countries going overseas mainly to the Euro Zone. All three countries are heavily dependent on foreign investment capital and will be hit hard in terms of any big move to risk-off.
Note: If you are bearish the euro - euro the proxies are correlated and will go down quicker and they are very often, better risk to reward trades - This is due to less speculative interest than EUR/USD which means more noise and price spikes. Also many of the proxies like the Eastern European currencies, for example, can also be considered emerging markets and this means there more vulnerable to a sell-off than the euro which is seen as a "safer" currency in times of risk-off.
Group 4: Emerging Markets
Chinese Yuan Offshore: The CNH is the offshore Chinese Yuan which is different from the CNY which is onshore. The offshore Chinese Yuan is not a free-floating currency and its rate is effectively fixed by the People's Bank Of China and despite the fact, the Chinese have had their currency accepted into IMF reserves we put in emerging markets due to its severe overvaluation, manipulation and weakness of the Chinese economy.
Mexican Peso: Major Export Market is the US and Mexico is also a major exporter of crude oil. The country has high USD debt levels and is heavily dependent on Exports. Traditionally the country has high-interest rates to attract foreign capital.
South African Rand: The country has high USD debt levels and is heavily dependent on Exports. Commodities to watch and major exports: Gems, precious metals: US$16.6 billion (17.5% of total exports) Ores, slag, ash: $11.8 billion (12.5%) Mineral fuels including oil: $10 billion (10.6%) Traditionally the country has high-interest rates to attract foreign capital.
Turkish Lira: Turkey has high levels of debt some of the highest of any emerging market economy and to service it the country has very high-interest rates. Probably the most vulnerable currency in terms of a major sell-off in our view
Russian Rouble: The worlds largest commodity exporter and the worlds biggest exporter of crude oil.
The Importance of Carry Interest.
In times of economic expansion, the risk currencies will do well in terms of the emerging market currencies they tend to borrow heavily and this is reflected in higher interest rates they need to offer to attract foreign investment. Currencies with high-interest rates tend to have high debt levels.
The emerging market currencies are very often used as carry trades in times of low volatility where the carry will often offset the small moves in a currency pair. For example, the Turkish Lira offers a rate of 19% annually against the Euro's negative interest rate so with leverage of 10:1 this means a 240% earning from the carry interest. This only works well in risk on when markets lack volatility.
In times of economic contraction or risk aversion, its the emerging economies which suffer the most and so do their currencies. Emerging markets are vulnerable to capital outflows as foreign investors pull out cash, bank loans are called in, loans coming fruition are not rolled over and new loans issued also fall.
Note: The above is the big picture in terms of the fundamentals important news etc of each individual currency this is also kept in mind in our daily summaries but over the long term the safer currencies as noted should generally move higher on risk currencies. In terms of the trading pairs and how we do it see notes below:
Notes On Trading the Groups
1. We are heavily focused on the JPY and were bullish on all major currencies going forward and at present, it's our major exposure.
2. The USD is our second biggest exposure and it won't collapse as many predict due to - its global reserve status and its been firm along with the Yen and we think will remain so
3. In terms of the CHF its a less volatile alternative to the JPY - Our preference is to do the more volatile JPY but CHF is a good alternative.
4. We will buy any currency in a higher group than another group and at present one of our favourite trades is GBP (Group 2) Over commodity currencies (Group 3) so it doesn't have to be 1 over 4 the technical set up and how overbought or oversold a currency is will be taken into account as well.
5. We will also buy within the same Group 3 - Where the CAD is clearly the strongest of the commodity currencies and a buy on the NZD AUD and NOK.
6. If a pair drops into consolidation for more than 14 days and we are still looking for a continuation of the trend we will cut allocation by at least 50% and free up capital to focus on moving pairs but still leave a trade in the market as a longer-term position.
7. The risk to reward is a minimum of 3:1 preferably 5.1 + and risk to stop is used to calculate position size used. Generally, we want a percentage gain on trade of 3 - 10% so all trades are treated as longer-term on entry.
8. If we are in a currency pair even if we still believe in the irection we initially picked and a better pair presents itself in our view we will liquidate and go for the best pair as we see it.
9. In terms of risk exposure when were doing well its normally up to 10% which is the level we are at now but will drop down if experience drawdown to 5%.
10. We will generally have 6 trades in terms of the 45 pairs we track:
A. If we think all the commodity currencies are going down for example on the JPY and we can't decide which is the best pair to trade we will trade the JPY V All 3 so AUD, NZD and CAD and treat it as one trade.
B. We will monitor each day and up risk or reduce in a pair and normally run 10% total risk exposure on all trades.
Our Current Trades: 29/08
JPY 4% Risk: EUR/JPY 2%, JPY V AUD, NZD CAD 2%
USD 3% Risk: NZD/USD AUD/USD 1% USD/TRY 0.5% USD V ZAR 0.5% V PLN CZK 1.0%
GBP 2% RISK: GBP V CAD, NZD PLN 2%
CAD 1% Risk: CAD V AUD NZD
The mix can change daily and the % can be reduced or increased depending on our view.
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