Forex Carry Trades Are in Trouble

Volatility is the forex investor’s greatest ally. In the month of September, there has been no let up from this key variable that had been missing during the Group of Eight central bank lower-for-longer interest rate stretch of the past two years. Volatility provides investors opportunity, something that has been in abundance for a number of weeks now, ever since investors started to price in the potential of interest rate differentials actually beginning to appear sooner rather than later.

Diverging monetary policies have been the driving force propelling both GBP and the USD higher as the Federal Reserve and Bank of England shift expectations toward a “normalization” of monetary policies. It’s been driving the EUR and JPY lower, too, as the European Central Bank (ECB) and the Bank of Japan maintain negative and zero interest rate policies while further expanding their balance sheets.

Investors Eye NFP and European QE

This is another heavy-laden data week, where new record EUR (€1.2679) and JPY (¥109.57) lows or even dollar highs are expected. Europe will kickstart the week’s trading activity with German preliminary inflation numbers. It tends to be an all-day event because the ‘actual’ is comprised of data from six-German states, which report their consumer-price indexes (CPI) throughout the day. Already, the five German states that have released the data for September suggest very little in the way of surprises on the pan-German CPI release later today. The preliminaries are hinting the market would see the expected +0.8%, year-over-year, print for German September CPI unchanged from its August level.

Also this week, both China and the U.K. will deliver manufacturing purchasing managers’ indexes by midweek, just after the market gets to gauge consumer confidence in the U.S. The ECB’s monetary policy meeting will dominate activity on Thursday. By now, the rate decision is often priced in to the market, so expect it to be overshadowed by President Mario Draghi’s post-meeting press conference. The market will be listening intently for any clues as to whether quantitative easing will be implemented or not.

Businesses and consumers across the 18 countries that share the single unit have been more downbeat about their prospects in September than at any time since the end of last year. This morning’s Economic Sentiment Indicator fell to 99.9 in September from 100.6 in August. Individuals are obviously disappointed with the pace of the eurozone’s economic recovery and the conflict in Ukraine. A further decline in this month’s confidence would suggest that the recent change in stimulus measures by the ECB is failing to convince both European households and businesses that the economic outlook will improve. With neither group unlikely to increase spending in the foreseeable future, euro economic expansion is not going to occur anytime soon.

Due to the eurozone’s second-quarter stagnation, the ECB has needed to be more proactive in announcing a fresh package of stimulus measures in early September (cutting key interest rates and suggesting two-bond buying programs). For Draghi and company, it’s too early to gauge any of the measures for growth and inflation; nevertheless, the market will be listening to his press conference for further reasons to add to any short-EUR positions.

Meanwhile, investors await the granddaddy of economic releases this week – the U.S. nonfarm payrolls (NFP) report. Scheduled to be released on Friday, the NFP’s importance usually makes for a hefty market impact. Also, Canada will produce its gross domestic product numbers in the first half of the week, while Canadian trade balance data will follow the U.S.’s own trade numbers release on Friday.

NZD Plummets on Intervention Concerns

Down Under, New Zealand’s monthly ANZ Business Outlook survey will be out later this evening. It’s a leading indicator of that country’s economic health. It’s worthwhile noting that the Kiwis’ business confidence numbers have been on a downward trend over the last six-months. Business sentiment is usually an early signal of future economic activity such as spending, hiring, and investment.

Kiwi traders certainly got the early jump on forex market. In overnight trading the NZD/USD has been in relative freefall, down as much as -150 pips and approaching the psychological NZD$0.77 handle. Governor Graeme Wheeler’s Reserve Bank of New Zealand posted its monthly operation metrics for August, revealing net sales (intervention) to the tune of NZ$521M — the biggest net sale in seven years. Wheeler and company moved to protect the country’s exporters from sharply falling commodity prices. Many analysts expect further Kiwi weakness — predominately from the highly concentrated carry positions. Nevertheless, they remain cautious about the future pace of decline. Despite implied volatility having spiked of late, the pace looks unsustainable — this may give the market better levels to offload bad positions or the ability to improve short NZD value.

Not being left behind is the AUD ($0.8724), very much a part of the interest-rate sensitive and commodity trio (CAD, NZD, and AUD). The AUD/USD continues to be crushed this morning, falling to a new eight-month low as it too has been caught in the Kiwi “downdraught.” Due to its proximity and because of it being a commodity-based currency, what hurts the Kiwi, hurts the Aussie and visa-versa. Despite the already impressive weakness being portrayed by the AUD, investors should expect Governor Glenn Stevens at the Reserve Bank of Australia to continue to suggest that his currency is overvalued. Most of this month’s selling squeeze has come from the long carry positions trying to exit one of the most crowded trades of this year. Tomorrow, investors get a peek at the Aussies’ monthly retails sales, and on Wednesday its building approvals and trade numbers.

Unrest in Hong Kong Worries Investors

Protests and violent clashes between police and pro-democracy protestors in Hong Kong is the main theme in pre-holiday Asian trading. The Hang Seng traded down by about -2.5% at its worst levels, but has since come off the lows on news that protester ranks have thinned and talks are taking place. Because Beijing opposes all kinds of illegal behavior in Hong Kong that undermines social stability, the market will of course remain nervous at least until investors understand where Chinese authorities stand on the issue.

Forex heatmap

This article is for general information purposes only. It is not investment advice or a solution to buy or sell securities. Opinions are the authors; not necessarily that of OANDA Corporation or any of its affiliates, subsidiaries, officers or directors. Leveraged trading is high risk and not suitable for all. You could lose all of your deposited funds.

Dean Popplewell

Dean Popplewell

Vice-President of Market Analysis at MarketPulse
Dean Popplewell has nearly two decades of experience trading currencies and fixed income instruments. He has a deep understanding of market fundamentals and the impact of global events on capital markets. He is respected among professional traders for his skilled analysis and career history as global head of trading for firms such as Scotia Capital and BMO Nesbitt Burns. Since joining OANDA in 2006, Dean has played an instrumental role in driving awareness of the forex market as an emerging asset class for retail investors, as well as providing expert counsel to a number of internal teams on how to best serve clients and industry stakeholders.
Dean Popplewell