Forex Investment and Currency Trading

The overwhelming majority of Forex trading volume is in the spot market. “FOREX” inevitably means spot trading to most participants. But it is possible to trade FOREX as a futures vehicle. The volume of futures FOREX has also increased. The primary advantage of futures FOREX lies in the fact that the futures markets are centralized and as such are more heavily regulated. A secondary advantage is that many popular technical trading methods use volume of trading and open interest. While aggregate volume is known in FOREX, daily figures are unobtainable because of the decentralized nature of the business.

A futures contract is an agreement between two parties: a short position, the party who agrees to deliver a commodity, and a long position, the party who agrees to receive a commodity. For example, a grain farmer would be the holder of the short position (agreeing to sell the grain) while the bakery would be the holder of the long (agreeing to buy the grain).

In a futures contract, everything is precisely specified: the quantity and quality of the underlying commodity, the specific price per unit, and the date and method to delivery. The price of a futures contract is represented by the agreed-upon price of the underlying commodity or financial instrument that will be delivered in the future. For example, in the grain scenario, the price of the contract might be 5,000 bushels of grain at a price of four dollars per bushel and the delivery date may be the third Wednesday in September of the current year.

Currency Futures
The FOREX market is essentially a cash or spot market in which over 90 percent of the trades are liquidated within 48 hours. Currency trades held longer than that are normally routed through an authorized commodity futures exchange such as the International Monetary Market. IMM was founded in 1972 and is a division of the Chicago Mercantile Exchange (CME) that specializes in currency futures, interest-rate futures, and stock index futures, as well as options on futures. Clearinghouses (the futures exchange) and introducing brokers are subject to more stringent regulations from the SEC, CFTC, and NFA agencies than the FOREX spot market (see www.cme.com for more details).

It should also be noted that FOREX traders are charged only a transaction cost per trade, which is simply the difference between the current bid and ask prices. Currency futures traders are charged a round-turn commission that varies from broker house to broker house. In addition, margin requirements for futures contracts are usually slightly higher than the requirements for the FOREX spot market.

U.S. Dollar Index
The U.S. Dollar Index (ticker symbol — DX) is an openly traded futures contract offered by the New York Board of Trade. It is computed using a trade-weighted geometric average of six currencies (EURO, Japanese Yen, British Pound, Canadian Dollar, Swedish Krona and Swiss Franc).

IMM currency futures traders monitor the U.S. Dollar Index to gauge the dollar’s overall performance in world currency markets. If the Dollar Index is trending lower, then it is very likely that a major currency that is a component of the Dollar Index is trading higher. When a currency trader takes a quick glance at the price of the U.S. Dollar Index, it gives the trader a good feel for what is going on in the FOREX market worldwide.

USD
The dollar has continued its recovery in the aftermath of the Paulson/Plosser comments. With many of the heavyweight US financial firms having reported Q2 earnings, the focus is likely to shift back to the relative fundamental outlook in the coming days. A better environment towards risk and the resilience of US equity markets suggests further near-term USD upside, which should be helped on a successful agreement in Congress on measures to support Freddie Mac and Fannie Mae. Oil prices remain a key focus and attention will be on weekly EIA oil inventory data. JPM expects oil inventories to increase. Such an outcome would keep oil prices under pressure to the benefit of both US stocks and USD.

EURUSD:  EUR depreciated last night as reports showed that industrial orders in May dropped more than twice as much as forecasted, mostly due to slowing global growth and EUR’s advance. Additionally, reinvigorated risk appetite on positive comments from US Treasury Secretary Paulson predicting Congress’ approval of the Freddie Mac and Fannie Mae rescue plan strengthened the dollar against EUR. EUR did make positive gains against other currencies on this news. Further concerns about Europe’s economy came from consumer spending numbers in France, which fell 0.4% in June. Expectations call for a decline in tomorrow’s European PMI, a monthly index of European manufacturing, to 48.7 this month from 49.2 in June. This could take EUR even lower. 

Although still bearish for the US economy as a whole, the market is finally pricing in the fact that the rest of the world is in a similar predicament if not worse. Levels to watch in euro include 50% retracement at 1.5670 (along with the deviation near there), and on the topside the 38.2% is at 1.5760 and there is some resistance at 1.58.

GBP/USD

GBP fell early last night on a stronger dollar across the board. However, minutes from the MPC July meeting have carried GBP upward this morning. While BoE kept rates unchanged at 5% two weeks ago, the tone of the statement was more hawkish than expected, with a more open discussion on the merits of a rate hike. The MPC concluded that hiking rates in July would send the wrong signal and would surprise fragile markets. They added that any rate move could be better communicated in August. After the release of minutes, expectations have increased that the MPC will hike rates by the end of the year. The coming UK economic data is likely to support the evidence that economic momentum slowed further, while the MPC will have been encouraged by the decline in oil prices and news that major UK superstores have reduced fuel prices. 
 
Look to sell cable at 2.0060/75 in front of the retail sales number tomorrow morning at 430am NY time. 1.9900 is a quadruple bottom and will be support – with mortgage approvals at new record lows and CBI coming in worse – the data continues to disappoint.

AUD/USD

AUD depreciated overnight on news that headline CPI was stronger than expected, but details of the report showed some moderation in core inflationary pressures.  Some analysts now expect a rate cut in February 2009. The reasoning is that the moderation in domestic growth appears to be intensifying which the RBA expects will curb inflationary pressures. Additionally, the stimulus from the commodity sector is likely to dissipate over the near-term which should lift domestic incomes. With the equity market backdrop more conducive to risk appetite, AUD should remain an out-perfomer in the weeks ahead.

NZD/USD

NZD continued its fall against the dollar on speculation that the RBNZ will lower interest rates as soon as tomorrow. The RBNZ is likely to sound dovish enough in the accompanying statement to suggest that rate cuts are likely in the coming months which should weigh down on NZD sentiment.

USD/JPY 
 
Having closed above the 200 day SMA overnight, intra day players have driven USDJPY higher this morning. In particular the pair has been supported by the strong performance from the Nikkei overnight. With the markets generally restabilizing, as shown by the rally in equities, JPY is becoming particularly weak against the world’s major currencies.  JPY  may fall even more if US Congress approves the Freddie Mac and Fannie Mae rescue plan.

USD/CAD 
 
Canadian CPI came out this morning at 0.7% m/m with 0.1% m/m core inflation (vs. expectations of 0.5% headline and 0.1% core). With the USD and commodities have begun to make a significant turn, the pair should move higher. CAD has been hit hard this month as oil prices have fallen significantly. In USD/CAD, keep an eye on 200-hr support at 1.0050 and resistance up at 1.0140 and 1.0180.

USD/BRL

BRL opened slightly down this morning ahead of the central bank’s announcement of the SELIC target rate this afternoon. Expectation is for the bank to raise the rate 50bp from 12.25 to 12.75. Yesterday BRL reached a nine-year high on speculation for a rate increase.

USD/MXN
MXN posted significant gains yesterday as investors bet the gap between Mexican and US benchmark lending rates widen, increasing demand for the nation’s fixed-income securities. Economists predict that Mexico’s central bank will raise rates 25bp to 8.25% in August. Interest rate hikes and a drop in oil prices suggest inflation will slow, further increasing demand for Mexico’s government securities. Relatively positive news out of the US is also carrying MXN upward since US is one of Mexico’s strongest trade partners.

Commodities Update
Crude oil prices continued to fall as Hurricane Dolly will probably miss the main US production areas and US oil supply data to be released today is expected to show a rise in gasoline stocks amid weakening global demand. Gold is also on the decline as USD continues its rally, shrinking gold’s appeal as a hedge.

USD: We may have just seen THE TURN in the dollar. With the dramatic technical breaks and very impressive price action, this has been a most excited news for USD in some time. So The list of dollar-positives is very long:

• US rates ripping
• Commodity bubble deflating
• Financials rally on bad news
• Unprecedented USD-positive M&A pipeline
• EUR-CEE4 turning
• Light at the end of the tunnel in Iraq
• Modified U.S. policy on Iran
• New president elected in four months.

List of long a USD basket: USD/JPY, EUR/USD, AUD/USD, USD/CAD, USD/BRL and USD/MXN; along with USD/BRL and USD/MXN. Much of the Brazilian macro story is predicated on commodities and the recent turn in the CRB suggests USD/BRL could rally significantly. Long commodities and short USD/BRL would be a common pair of positions in a macro fund so if the commodity deflation accelerates, funds will be forced to cover USD/BRL shorts to cover losses.