Traders who follow the currency market like to fancy themselves as macro experts. They obsessively follow every economic release in the G-10 universe and know the results of every report down the final basis point. But while eco data can definitely move the market over the near term horizon it’s rarely the true driver of prices in the long term.
Traders always forget that currencies, unlike almost all other financial assets are first and foremost political rather economic instruments. Fiat currencies are nothing more than state sponsored promises to make good on your money.
That’s why being a political animal can make you a much better investor in the Forex market than just looking at the latest economic data.
Make no mistake about it- all major policy decisions in the G-10 complex are political – even if they are made by monetary officials whose primary job is to steward the economy. Let’s take a look at the actions of the two biggest central banks in world to see what I mean.
Earlier this year Mr. Draghi and his minions in Frankfurt faced a very serious problem. Unlike the Fed, which is empowered to both sustain growth and contain inflation, the ECB is only mandated to maintain price levels. Yet, as the only pan-European organization, the ECB is the one European institution with any real economic power.
The EZ economy was in tatters, growth was non existent and the euro was much too high, choking off export demand and putting even more deflationary pressure on prices. The question for Super Mario was – how do you stimulate a moribund economy while adhering to the constraints of your mandate?
Just change the narrative and pretend that your policy actions are focused on inflation rather that growth. You simply state that you need to follow your target of 2% inflation and therefore need to pump massive amounts of credit into the system to raise prices. Voila! The biggest QE program in the history of ECB is born overnight. Suddenly, the euro is no longer an anchor around the neck of your exporters, growth begins to pick up and labor conditions improve.
Now move forward to the first week of December. EZ growth has picked up, the euro has lost more 15% of its value, but disinflation still reigns. CPI remains at 0.9% – well below the ECB target of 2%. So the ECB continues with its massive stimulus because prices are still far away from target?
Silly you! You are thinking like an economist.
As far as ECB is concerned, the heavy lifting has already been done. Growth has started and exchange rates are comfortably below your internal target of 1.1000, so of course you take your foot off the pedal because you don’t want to drive your currency to parity too fast.
And that’s how you get the biggest daily jump in the EUR/USD in 6 years as the market …solely focused on economic data…completely misses the political motives behind the scenes and has to cover all those short euro bets.
Now let’s turn our attention to the Fed. After playing “will they, won’t they” game with the market for more that 2 years, the FOMC officials have boxed themselves into the corner.
They HAVE to hike rates at the December meeting or lose whatever shred of credibility they have left. This despite the fact that there is no rational reason to move off the zero bound standard. The economy is basically hobbling along. There is nothing even remotely resembling a housing bubble in 99% of America that does not include the 10024 or 94101 zip codes. Commodity prices are scraping bottom and wages are growing at a puny 0.2% pace.
But the Fed wants to hike. As Bob Michaels head of JP Morgan Asset management tells Barron’s, “In the 34-plus years that I’ve been managing money, the Fed has raised rates either because it sees inflation starting to become a threat, or because growth is accelerating, in which case inflation is already here. This is the first time the Fed is going to raise rates just because it doesn’t like keeping them at zero.”
That’s why anyone who thinks like an economist will be fooled by the policy action in December once again. Not only will the Fed do “one and done” in December …mainly because it is a gratuitous action anyway. But even if the economy picked up steam in 2016, the Fed would stay resolutely neutral the whole year long.
Why? Politics of course. The Fed would never risk a contractionary shock during an election year. So even if the US economy suddenly became blazing hot, Ms. Yellen and company are sure to remain unflappably cool because in the currency markets, politics always trumps economics.
Until next time,
Mr. Schlossberg is a weekly contributor to CNBC’s Squawk Box and a regular commentator for CNBC Asia and CNBC Europe. His daily currency research is quoted by Reuters, Dow Jones, Bloomberg and Agence France Presse newswires and appears in numerous business publications and newspapers worldwide. Mr. Schlossberg has written articles on trading for SFO magazine, Active Trader and Technical Analysis of Stocks and Commodities. He is the author of Technical Analysis of the Currency Market and Millionaire Traders: How Everyday People Beat Wall Street at its Own Game, both of which are published by Wiley. Boris’ extensive experience in trading and developing momentum based techniques provide the foundation for BKForex’s strategies.