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THE YEN AND JAPANESE BONDS p. 22

SPOT CHECK:AUD/USD p. 16MULTI-MOVINGaverage trend systemfor currencies p. 18

ovember 2010

Volume 7, No. 11

Strategies, analysis, and news for FX traders

DOES THE AUSSIE DOLLARhave some gas left in the tank? p. 33

QUANTITATIVE EASING:Dollar in the balance? p. 6Much ado about nothing? p. 12

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CONTRIBUTORS

4 November 2010 CURRENCY TRADER

Editor-in-chief: Mark Etzkorn

[email protected]

Managing editor: Molly Goad

[email protected]

Contributing editor:

Howard Simons

Contributing writers:

Barbara Rockefeller,

Marc Chandler, Chris Peters

Editorial assistant and

webmaster: Kesha Green

[email protected]

President: Phil Dorman

[email protected]

Publisher, ad sales:

Bob Dorman

[email protected]

Classifed ad sales: Mark Seger

[email protected]

Volume 7, Issue 11. Currency Trader is published monthly by TechInfo, Inc.,PO Box 487, Lake Zurich, Illinois 60047. Copyright 2010 TechInfo, Inc. Allrights reserved. Information in this publication may not be stored or reproducedin any form without written permission from the publisher.

The information in Currency Trader magazine is intended for educationalpurposes only. It is not meant to recommend, promote or in any way imply theeffectiveness of any trading system, strategy or approach. Traders are advisedto do their own research and testing to determine the validity of a trading idea.Trading and investing carry a high level of risk. Past performance does notguarantee future results.

For all subscriber services:www.currencytradermag.com

A publication of Active Trader

CONTRIBUTORS

q Howard Simons is president of Rose-wood Trading Inc. and a strategist for BiancoResearch. He writes and speaks frequently ona wide range of economic and nancial market

issues.

q Daniel Fernandez is an active trader witha strong interest in calculus, statistics, and eco-nomics who has been focusing on the analysisof forex trading strategies, particularly algorith-mic trading and the mathematical evaluation of long-term system pro tability. For the past two

years he has published his research and opinions on his blogReviewing Everything Forex, which also includes reviews

of commercial and free trading systems and general interestarticles on forex trading ( http://fxreviews.blogspot.com ).Fernandez is a graduate of the National University of Colom - bia, where he majored in chemistry, concentrating in computa-tional chemistry. He can be reached [email protected] .

q Barbara Rockefeller (www.rts-forex.com ) is an inter-national economist with a focus on foreign exchange. She hasworked as a forecaster, trader, and consultant at Citibank andother nancial institutions, and currently publishes two dailyreports on foreign exchange. Rockefeller is the author of Tech-nical Analysis for Dummies(For Dummies, 2004), 24/7 TradingAround the Clock, Around the World(John Wiley & Sons, 2000),The Global Trader(John Wiley & Sons, 2001), and How to InvestInternationally , published in Japan in 1999. A book tentativelytitled How to Trade FXis in the works. Rockefeller is on the board of directors of a large European hedge fund.

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*Exchange fees apply on all data.eSignal is a registered service mark of Interactive Data Corporation. Interactive Data Desktop Solutions (Europe)

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GLOBAL MARKETS

Heading into the final months of 2010, the global economyis continuing to rebound from the financial crisis, buttheres a clear dichotomy between mature and emerg-ing economies, with the latter leading the growth charge.This has left several major powers, including the U.S. and Japan, grappling with the challenge of finding new waysto inject even more stimulus into their growing but still-sluggish economies.

The situation raises several questions for traders andinvestors, especially in the forex arena. Some marketobservers wonder why additional stimulus in the form of

central bank purchases of Treasuries so-called quanti-tative easing (QE) is being implemented. Did the firstround work, or not? What impact will the new round of quantitative easing (QE2) likely have on the U.S. andglobal economies? What are the risks of QE2 for the dollar?Finally, what are the other likely currency winners and los -ers in the next few months if QE2 occurs in the U.S.?

Unbalanced GDP growthAnalysis of global gross domestic product (GDP) ratesreveals the unevenness of the economic recovery.Nomuras late-October forecasts have 2010 global GDPcoming in around 4.7 percent, with emerging-market econ -omies leading the way at a 7.2-percent pace and developedeconomies trailing significantly at 2.5 percent. The BRICs(Brazil, Russia, India, and China) are expected to have thestrongest growth at 8.7 percent.

Nomura forecasts the global economy to slow to a 4-per -cent pace in 2011, with developed nations downshiftingto a 1.9-percent rate. Credit Suisse forecasts global GDPgrowth at 4.7 percent this year and 4.3 percent in 2011.

The global economy continues to grow, but at a rela-tively subdued pace, especially in the advanced econo-mies, says Jay Bryson, global economist at Wells FargoSecurities. He says advanced economies remain weigheddown by leverage problems that need to be corrected,

including personal balance-sheet issues of individual con-sumers. However, as they continue to save more and paydown debt, consumer spending weakens, Bryson notes a conundrum for any economy powered in large part byconsumer spending.

Debt issues take a long time to work through, henotes. There isnt a magic bullet to turn this around over-night.

U.S. numbers have expanded from the financial crisis, but they are not robust. According to Credit Suisse, first-quarter GDP was 3.7 percent, second quarter was 1.7

percent, third quarter is estimated at 2.6 percent, and thefourth quarter forecast is 1.6 percent an overall annualaverage growth rate of 2.8 percent for the year.

Also, unemployment remains stubbornly high andinflation remains dangerously low, with some economistsworried the balance could tip toward deflation. In AugustU.S. Federal Reserve chief Ben Bernanke first hinted theFed would renew Treasury purchases, and reinforcedthe message in October. At its Nov. 2-3 meeting, the Fedannounced it would purchase $600 billion of additionallonger-term Treasuries by the end of the second quarter of 2011 (approximately $75 billion per month).

From QE1 to QE2How did the global economy get to this juncture? JamesPressler, associate international economist at the NorthernTrust Company notes the global economy was floodedwith money in late 2008 to kick-start growth.

For a brief period, it stimulated demand and sentgrowth rates back up, he says.

However, Pressler points out this was a temporary fix.Lets face it, stimulus is spiking the punch bowl, he says.You really want to get the party going? Dump rum in thepunch bowl. And at the end of 2008 and into 2009, a lot of rum was being thrown in the global punch bowl.

But as is often the case after too much of a good thing,

QE2: Who wins, who loses?

Find out which currencies are in the best and worst positions as the

Fed renews stimulus efforts via quantitative easing.

BY CURRENCY TRADER STAFF

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7/33CURRENCY TRADER November 2010

Pressler notes, were now suffering the after-effects.Now, many people are saying, I dont feel so great,

he says.Fast forward to mid-2010: The economic recovery rate in

the U.S. was at a much slower pace than the Fed expected,according to David Jones, president and CEO of DMJAdvisors and former 35-year Wall Street economist.

The pace is so slow its unlikely to bring down theelevated unemployment rate, he says. The Fed is readyto respond with a carefully calibrated second round of quantitative easing.

Its not necessarily that the first round of QE didntwork. Instead, Jones says, after a financial crisis as bigas weve been through, financial institutions are still dele-veraging. Also, consumers are still trying to reduce their balance sheets, which is a significant factor limiting therecovery.

After the Nov. 2-3 meeting, the Fed announced addi -tional QE with the goal of easing financial conditions and

to put downward pressure on long-term interest rates,according to Jones.However, theres some discord within the Fed regarding

the appropriateness of a second round of bond purchases,and much debate in the financial community regarding itspotential impact.

Bryson says simply: I dont know how much it willactually do.

How much of QE2 is already priced into long-term inter -est rates?

[10-year Treasury yields] have fallen from 2.8 percent inAugust to around 2.5 percent now, Jones says. The stock market has rallied strongly and the dollar has plummeted.

One could argue the markets have largely discounted amilder version of quantitative easing. Jones estimates the markets had currently priced in

roughly $500 billion in purchases of longer-term Treasuriesover a six-month period. (The first round of quantitativeeasing in 2008-2009 represented around $1.725 trillion.)The actual number came in around $100 billion higher.

Now that we have a much improved financial sector,we have to ask how much more bang for the buck you getfrom pushing long-term rates lower, he says. Jones alsowonders how the political environment feeds into the cur-rent caution in the business community regarding hiringand investment.

Theres uncertainty in the business sector, with thethreat of higher taxes and uncertainty over regulation,he says. Given there are other factors that have caused businesses to be very cautious regarding hiring, in thesecircumstances a second round of quantitative easing maynot have the impact the first round had.

Overall, Jones believes additional stimulus will likelyhave some impact, but concedes the Fed is basically run -ning out of ammunition in terms of easing financial condi-tions.

The inflation argumentIn addition to its known risks, theres the issue of unin-

tended consequences of renewed quantitative easing.The goal of QE is to lower long-term interest rates evenfurther to stimulate economic action. However, theresalways risk that low rates could inflate asset price bubblesagain, according to Bryson. He believes emerging-marketequity and property markets, which have been perform-ing strongly, are potential bubble areas. (For more on thecycle of central bank-driven bubbles and busts, see Theimportance of being carried in the January 2011 issue of Active Tradermagazine, on newsstands in December.)

For every economist harping about current deflation,you can likely find another who will warn the danger wemay face is future inflation.

If you keep rates too low, too long, further out youcould end up with high inflation in terms of goods andservices, Bryson says.

Pressler adds, Some people argue if that money getsput to work, it could cause significant imbalances andaggravate inflation.

Jones says the biggest danger is that the Fed is per -ceived as monetizing Treasury debt in relation to a run -away deficit, which could eventually destabilize inflation.The lesson that the Fed learned from the 1970s is they haveto keep inflation expectations stable at all costs.

What about Japan?Any discussion of U.S. quantitative easing winds its wayto Japans efforts in the same vein, and its ongoing fail-ure to combat the countrys chronic economic stagnation.Many critics of Japans nearly 20-year battle with deflationsay the Bank of Japan (BOJ) and Ministry of Finance sim -ply havent been aggressive enough in attacking deflation.

Japan has struggled with deflation for more than adecade, and growth remains sluggish. According to CreditSuisse, Japans first quarter GDP came in at 5 percent, butit slowed to 1.5 percent in the second quarter. The thirdquarter is forecast at 2 percent and the fourth quarter at-0.9 percent.

Presslers research team believes before 2010 is over Japan could fall back into a technical recession, with two back-to-back quarters of negative GDP growth.

Recently, Japan announced a fresh round of quantitativeeasing and began taking steps to rein in the runaway bulltrend in the yen, which recently posted a 15-year high vs.the dollar (Figure 1). In September, Japanese authoritiesreportedly intervened in the FX markets for the first timesince 2004, selling about 2.1 trillion yen.

Also, in early October the BOJ cut its official overnightcall rate from 0.10 percent to a range of zero to 0.10 per -cent, and announced it would set up a 5-trillion yen fund($60 billion) to buy government bonds and other assets.

Figure 1, however, suggests the latest QE from Japan hashad little impact as the yen continues to strengthen againstthe dollar.

You may not see an immediate response, says TuPackard, senior economist at Moodys Analytics. This is a big struggle. Put yourself in the BOJs shoes theres onlyso much they can do.

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GLOBAL MARKETS

However, Pressler looks at the ris -ing yen and Japans recent QE from adifferent perspective.

If anything, the FX markets treatit as a validation that the BOJ is veryworried about deflation, he explains.They arent thinking this is necessar-ily the cure for deflation.

Pressler says for the BOJ to make adifference, it must keep its foot onthe pedal and take a firm stance. Tellthe market were going to throw yenat you until we see a reversal of thisdeflation situation.

Despite his earlier commentsregarding stimulus, Pressler, who hasstudied the Japanese situation closely,says QE2 in the U.S. has to be done.Whether it causes a dramatic turn-around is hard to say. But it puts afloor under the economys woes, andthats a good start.

Market maneuversWith renewed quantitative easingcoming from the U.S. Fed, the nextquestion is how to trade it. What arethe expected currency winners andlosers in November and December

as the market begins to deal with theimpact of the new stimulus?First, market watchers agree QE is

bearish for the dollar. The goal, afterall, is downward pressure on long-term rates, which makes it less attrac-tive to invest in U.S. assets, Jonessays.

Since mid-June the U.S. dollar has been in a bear trend vs. the Euro, withthe EUR/USD pair jumping from$1.18 to $1.41 in mid-October (Figure2). Few expect the dollar to signifi -cantly reverse its relative weakness inthe near future.

We think the dollar will be broadlyweaker against all the major curren-cies, says Dan Katzive, currencystrategist at Credit Suisse.

Nick Bennenbroek, head of cur -rency strategy at Wells Fargo, holds asimilar outlook, pointing out that QEincreases the supply of dollars.

According to the law of supplyand demand, that will be bearish forthe dollar, he says. We suspect the

FIGURE 1: ANOTHER YEN MILESTONE

Although Japan recently began taking steps to rein in a runaway bull trend in the yen, including a renewed quantitative easing campaign and FX market intervention, the dollar/yen pair has fallen below its 1995 low.Source for all figures: TradeStation

FIGURE 2: EURO REBOUND

After falling to its lowest level since 2006 in early June, the Euro/U.S. dollar pair jumped 19 percent 1.4158 in mid-October before consolidating. Most analystssee further gains in the pair by year-end.

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10/3310 November 2010 CURRENCY TRADER

dollar will continue to weaken after we get quantitativeeasing. To an extent, you can argue its priced into the mar-ket, but it will continue to be a negative force on the dollar.Theres always the possibility of more QE.

Bennenbroek targets additional Euro/dollar strength,taking the pair toward $1.4300-1.4500 by year-end.

More gains aheadOther expected beneficiaries of the current scenario aremostly currencies that have already chalked up healthygains this year.

The main winners will be commodity-based currencieslike the Australia and New Zealand dollars and Canada

could probably do okay, Bennenbroek says.Australia and New Zealand especially are in a positionto benefit from favorable interest-rate differentials.

While the U.S. is holding official interest rates at nearzero, Australia and New Zealand are quite likely to seeinterest rates move higher, Bennenbroek explains. Heforecasts medium-term gains in those currencies, with a12-month target of 1.0600 in the Aussie/U.S. dollar pair(AUD/USD) and .8000 in the New Zealand/U.S. dollarpair (NZD/USD). Figure 3 shows a weekly chart of bothpairs.

Sebastien Galy, currency strategy at BNP Paribas, seesAsian currencies relative to the dollar

as QE2 winners.Relative to mature markets, QE2is already priced in, he says, add -ing, $500 billion [in QE] was alreadypriced into the Euro/dollar at $1.3850.This, he contends, means Asian cur -rencies such as the Indonesia rupiah(IDR), Korean won (KRW), and Indianrupee (INR) are a safer bet on a multi-month basis.

However, he stresses that gains inthese currencies vs. the dollar are morelikely to be gradual rather than large,sudden moves.

Upside dollar correction?Galy thinks the U.S. dollar may be ripefor a corrective move in the short-term.The market is poised for a correction profit-taking type of behavior, hesays. Weve been trending in the short-dollar/long-risk assets since the endof August. My guess is we will see acomeback in the dollar.

He anticipates either shock ordisappointment in QE2 as a potential

catalyst for this near-term profit-taking, which could takeEuro/dollar below $1.3500 by year-end.

Although Galy expects any dollar rally to be a counter -trend move in the longer downtrend, he believes it could be a fairly brutal correction. For example, he pegs poten -tial for Aussie/dollar to retreat to the .8700-.8500 zone onsuch a move.

Everyone has the same position on, he notes. It willwash out in a week or two.

After this episode Galy ultimately sees a stabilization,then recovery and back to the same risk trade. Followingthe correction, he expects risky assets to outperform with a bias toward long-Asia/short-dollar trades.

As always, traders need be cautious heading into year-end because of potentially less-liquid conditions in theforex world and other financial markets.

Market makers willingness to take risks will bereduced because they are defending their compensationgoing into year-end, Galy notes.

Time-honored advice includes limiting risk and protect-ing profits.

For the retail trader, the potential for slippage is signifi -cant, Galy warns. Dont take too much risk going intoyear-end. y

GLOBAL MARKETS

FIGURE 3: BENEFITS DOWN UNDER

The already strong Australian and New Zealand dollars are poised to benefit over time from continued U.S. dollar weakness. However, some analyststhink the U.S. currency could experience a strong countertrend rebound beforeanother major bear move emerges.

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As the dollar started to rally in late October, a newswireran the headline Inflation fear drives dollar higher. Waita minute. Inflation fear causes currencies to fall, doesnt it?

Yes. (Be careful what you read.)So, what is really happening, and whats likely to hap-

pen next? First, inflation. The inflation fear in the head -line is deduced from the auction of five-year TIPS (infla -tion-adjusted Treasury notes), which sold at $105.50 for a$100 face value, or an initial negative return on a nominal

basis of -0.55 percent. Investors will get a positive returnif inflation goes up. That investors were willing to over-pay to get their hands on inflation-protected notes meansthey believe inflation will rise. From Fed Chairman BenBernankes point of view, this is a good thing, or at least aless-bad thing. A little fear of inflation is better than panicover deflation.

Economists and market mavens cant agree on how tomeasure inflation expectations. Just comparing the yield

on T-notes against the same-tenor TIPSfails to account for the lesser liquid-

ity in TIPS. Even so, the breakeven between the protected and unpro-tected had risen from 1.13 percent lastsummer to about 1.78 percent in lateOctober.

Another measure is the spread between the 30-year and the 10-year,which stands at around 1.30 percentin late October, or a difference of 0.48percent from the same-tenor five-yearcomparison. Both measures purport toput a number on inflation expectations, but this is a pretty big margin of error.

Of course, you can always ask con -sumers what inflation they expect,and fat lot of good that does you. Thelate-October Conference Board sur -vey showed U.S. consumers expectinflation to rise to 5 percent in oneyear, from about 2 percent currently.Because home prices are included inthat reckoning, a high forecast may bewishful thinking. In any case, 5 percentis outrageously and unrealisticallyhigh, and suggests even greater eco-nomic illiteracy than we imagined.

On the Money

12 November 2010 CURRENCY TRADER

ON THE MONEY

Dont fight the FedQuantitative easing, and its likely impact, is widely

misunderstood except when it comes to the dollar.

BY BARBARA ROCKEFELLER

FIGURE 1: REACTION TO PROPOSED QE2

The dollar initially fell at the prospect of a new round of quantitative easing, but then rallied in late October when it emerged the amount might be as low as$200 billion.Source: Chart Metastock; data Reuters and eSignal

2August

9 16 23 30 6September

13 20 27 4October

11 18 25 1 8November

15 22 29

757676777778787979808081818282838384848585Dollar Index (77.6240, 78.2730, 77.5590, 78.1490, +0.44100)

-1.2-1.1-1.0-0.9-0.8-0.7-0.6-0.5-0.4-0.3-0.2-0.10.00.10.2MACD (-0.66432)

Dollar drops onprospect of QE2

Dollar rises on talkof small QE2

Dark red 100-daymoving average con-verges to green 200-day moving average

U.S. dollar index (DXY), daily

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13/33CURRENCY TRADER November 2010 13

New talk of inflation, however unrealistic, may mark the end of the deflation scare that is one of the top justifi-cations for quantitative easing (QE). And that leads us tothe second big factor pushing interest rates and currenciestoday. Bernanke made it clear at the Jackson Hole central bankers meeting in late August that a second round of QE, dubbed QE2, was on the table. Estimates of the sizeof this second round ranged initially from $500 billion, anumber mentioned by New York Fed President William C.Dudley, to Goldman Sachs $2-4 trillion. The very thoughtof another round of QE riled knee-jerk monetarists, who believe a giant increase in money supply invariably leadsto inflation, all else being equal. The dollar fell on theprospect of QE2 and then rose when it emerged in lateOctober that the amount might be as low as $200 billion(Figure 1).

But of course, all other things are not equal these days.Its a mistake to apply the monetarists rule that inflation

is always and everywhere a function of an increase inmoney supply without also considering the velocity of money. Extra money that just sits in bank reserves (earninginterest, by the way) does not promote economic activity,and thus does not create inflation. The Fisher equation, onwhich the monetarist rule is based, states that money sup-ply times velocity equals production times inflation.

The velocity of moneyWhat is velocity? The turnover rate of money in the realeconomy. Under fractional reserve banking, when I paythe plumber $100, he deposits the check in the bank andthe bank sets aside a fraction, say 15 percent, as reserves,

and lends out the remaining $85. The baker borrows the$85 to pay for butter and the dairyman deposits his check in his bank. The banks again reserves 15 percent and lendsthe remaining $72.30 to the carpenter, who pays his lum - ber bill, and so on. The resulting multiple use of the samemoney is named the multiplier effect.Some folks dislike debt so much on gen-eral principle they fail to appreciate thatthe debt component of money supplyis the key driver of economic growth. If we didnt have fractional reserve bank-ing, we wouldnt necessarily still bedriving horse-drawn buggies, but wewouldnt have the technology-laden lifewe have today, either.

Figure 2 shows the money multiplierfrom the St. Louis Fed. The multiplieralways drops during a recession, butthe drop in the 2008-09 recession wasextraordinarily steep. The multiplier iscreeping up in 2010, but is less than 1,meaning money is being re-used orlent out by banks at a snails pace. Look at the left-hand side of the multiplierchart, when it was more than threetimes higher in 1985.

We cant blame just the banks, although paying intereston reserves is kind of silly if what the Fed really wants todo is to goose lending. The reason the multiplier is so lowis that everyone, from consumers to banks, is rebuildingtheir balance sheets after the crisis. Consumers are reduc -ing debt, at an annual rate of 4.4 percent in 2009 and 2.3percent in the first half of 2010. With the housing marketnow tied up in knots because of the foreclosure problem,much mortgage lending is stalled. Bank lending to corpo-rations has contracted as companies are sitting on a $1 tril -lion-plus pile of cash from seven quarters of good earningsand borrowing little and those who do want to borroware able to tap the bond market for seemingly unlimitedsums at record low rates. IBM, for example, issued a $1.5 billion three-year note in August for a measly 1 percent. Junk-bond issuance is accelerating in 2010. Deleveragingwas always in the cards after the financial crisis, and so itshould surprise no one that lending is taking a hit from

both the supply and demand side.This is one reason (and a good sone) some economistsproject that another round of QE is not going to do muchto boost economic activity or inflation. In fact, some econo-mists notably Kansas City Fed Chief Thomas Hoenig believe it would be better to let the market know extraor-dinary measures are no longer needed and that woulditself boost activity. According to Hoenig, There is simplyno evidence the additional liquidity would be particularlyeffective in spurring new investment, accelerating con-sumption, or cushioning or accelerating the deleveragingthat is hopefully winding down.

Hoenig is a minority of one at the Fed, however, which

implies the Fed will be buying additional T-notes for thenext six months and perhaps longer unless and until theeconomy picks up to the Feds satisfaction and/or infla -tion does actually appear. As of late October, no one knowshow much it will buy. A Wall Street Journalsurvey in early

FIGURE 2: M1 MONEY MULTIPLIER

The multiplier always drops during a recession, but the drop in the 2008-2009recession was extraordinarily steep. (Shaded areas indicate U.S. recessions.)Source: Federal Reserve Bank of St. Louis http://research.stlouisfed.org/fred2/series/MULT

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ON THE MONEY

October showed a consensus among economists that theFed would buy $250 billion per quarter for a total of $750 billion. The New York Feds Dudley said his estimate of $500 billion is equivalent to a 0.50 percent to 0.75 percentcut in the Fed funds rate. Reuters points out the Fed hasto buy $30 billion per month just to reinvest early repay -ments from its portfolio of mortgage-backed bonds. Forperspective on Goldman Sachs forecast of $2-4 trillion, theoriginal announcement of QE was for $1.75 trillion.

One of the Feds goals in engaging in another round of QE2 is to keep the long end of the yield curve low. Becausefinancing costs for everything from mortgages to junk bonds are built off the 10-year Treasury note, and becausethe Fed seeks to boost activity, low rates all along the yieldcurve are the desired outcome. In contrast, a steepeningyield curve is a sign the bond market is building in higherinflation expectations. Therefore, to say the Fed is activelyseeking to create inflation is to misunderstand the Fedsgoals. The Fed wants just enough inflation to be able tosay deflation has been beaten back, but not so much infla-tion that the yield curve steepens.

Other implicationsKeeping interest rates low has ramifications in other areas,including commodity prices. The knee-jerk reaction amongoil, gold, and other commodity traders is that QE willcause inflation, which should cause the dollar to fall, thusmaking hard assets a refuge. But if financial assets yield

practically nothing, you might as well take a pass on non-yielding assets and hope for a speculative price gain. Themore this approach pays off, the more people get suckedinto commodity trades. Some are professionals whosemanagers insist on meeting combined-asset benchmarks,and some are amateurs who think they are following thesmart money. These two constituencies are fickle, andtheir fickleness forms the basis for expecting burst bubbles.Hot money is exactly what it sounds like money thatcan reverse direction and exit in less than 24 hours.

Such hot money money that reverses direction andexits in less than 24 hours is under the careful watch of emerging-market ministries of finance and central banks,too. Brazil and China are just two of the emerging marketswhere authorities are imposing new regulations, taxes,or both to tone down hot money inflows. They have twofears: pressure on the currency to rise excessively frominvestor demand, and the possibility of a fast exodus if a bubble bursts. The lessons of the 1997-98 Asian crisis werewell-learned by emerging-market governments, if not byinvestors, who always think they will be able to escape before the mud hits the fan. In Figure 3, which showsselect emerging-market stock indices, Bombay, Brazil,and Mexico are moving in lockstep; only the ShanghaiComposite lags.

Emerging-market currencies are misaligned, as theInternational Monet ary Fund puts it. Accordin g to TheEconomistsBig Mac purchasing power parity calculations,

the Brazilian real is overvalued by 42percent. In fact, the Euro is overvalued

by 29 percent and the Swiss franc bymore than 80 percent. Meanwhile, cur -rencies from China, Russia, Mexico,and South Korea are undervalued by20 to 40 percent. This means Mexico,for example, has a competitive advan-tage over Brazil.

Brazilian Finance Minister GuidoMantega spoke of currency warsin late September, and this was a bigtopic at the G20 finance ministersmeeting in October. At that meeting,preliminary to the head-of-state sum-mit on Nov. 11-12, member countriesagreed they will move towards moremarket-determined exchange rate sys-tems and refrain from competitivedevaluation of currencies. In addition,Advanced economies, including thosewith reserve currencies, will be vigilantagainst excess volatility and disorderlymovements in exchange rates. Theseactions will help mitigate the risk of excessive volatility in capital flows fac-ing some emerging countries.

U.S. Treasury Secretary Geithner may

FIGURE 3: EMERGING-MARKET STOCK INDICES

Brazil and China are just two of the emerging markets imposing new regulations,taxes, or both to tone down hot money inflows. They have two fears: pressureon their currencies to rise excessively from investor demand, and the possibility of a fast exodus if a bubble forms and bursts.Source: Chart Metastock; data Reuters and eSignal

007 M A M J J A S O N D 2008 M A M J J A S O N D 2009 M A M J J A S O N D 2010 M A M J J A S O N

707580859095

100105110115120

125130135140145150155160165170175180185190195200205210215220

x100

Bombay Sensex OrangeBrazil Bovespa BlackMexican Bolsa BlueShanghai Composite Green

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have been seeking coordinated pressure on China in par -ticular, which promised a faster pace of yuan appreciationin June but delivered only about 2 percent by late October.But the outcome is symmetrical developed countries,including the U.S., have a responsibility not to devalue,too. In fact, just as the U.S. may be charging China withunfair trade subsidies in the form of an undervalued cur-rency, China could charge the U.S. with an unfair tradesubsidy by engaging in quantitative easing that pushesthe dollar down. The Chinese commerce minister told theFinancial Timesthe amount of dollars being issued by theU.S. is out of control and is leading to an attack of imported inflation.

Good grief, everyone believes QE will lead to inflationand devaluation even though that would be true only if the velocity of money were to pick up to normal levels.It might also be true if imports were a high percentage of GDP, but in the U.S. as of August, imports were $200 bil -lion, or only about 0.001 percent of GDP hardly enoughto have an inflationary effect.

One reason for the widespread adherence to the false belief is the level of U.S. government debt. No one doubtsthe U.S. budget is on an unsustainable path. In the 2010 fis -cal year (just ended on September 30) the deficit was $1.29trillion, or 8.9 percent of GDP. Debt held by the public is$9.2 trillion (63 percent of GDP) and will reach $18.5 tril -lion (78 percent of GDP) in 10 years. By contrast, considerthe EMU Stability Pact calls for debt not to exceed 60 per -cent of GDP, and in the 40 years from 1960 to 2000 in theU.S., debt averaged 37 percent of GDP. The UK, with debt

at only 53.1 percent of GDP, engaged in a massive 81 billion cost-cutting campaign in October to avoid a ratingsagency downgrade. The U.S. is nearing the point whererating agencies grumble and threaten downgrades. Despitehaving reserve currency status, the U.S. is vulnerable to adowngrade and would have to pay higher rates of returnto attract the same level of foreign investment in its notesand bonds.

What does this have to do with inflation? Nothing,except the perception that when a country becomes over-indebted, a nifty way out is to devalue. As written manytimes before (see Bucks, bonds and the new bully intown, Currency Trader , November 2009), there is no evi -dence this is the intent of anyone in government, past orpresent. Also, if the Federal Reserve seeks to hold downinterest rates across the yield curve, it would logically havea strong interest in better fiscal management, although itfears losing its prized independent status by interfering inwhat is essentially a political matter.

Another round of quantitative easing, along with a too-high public deficit, gives foreigners a big headache. Forone thing, it does nothing to assuage fear among holdersof the dollar as a reserve currency that the U.S. is not seek -ing to debase its currency. (Technically, debasing meansto clip the edges of a gold or silver coin, which is hardlyrelevant today, but the term endures.) Again, half-seeing

monetarists are sure that creating all that money will cre-ate inflation and the U.S. intends to devalue its public debtthat way. To raise money supply is also in direct contradic-tion to the emerging G20 consensus that every memberhas a responsibility to the others to take whatever steps arenecessary to maintain FX market stability and not to usecurrency policy to promote its self-interest. The U.S. wantsChina to revalue the yuan faster, but China wants the U.S.to stop taking actions that devalue the dollar.

This is not to say the Fed can be expected to alter itsdecision because of objections by other G20 members, butit cant be entirely unmindful of the international response.In fact, the U.S. may have to make some kind of gestureat the G20 summit in Seoul on Nov. 11 to offset whateverQE action the Fed takes the week before. The days are longgone when the U.S. treasury secretary can just speak thestrong dollar, best interests mantra and get the desiredoutcome.

Damned if you do...Its a harsh judgment, but the U.S. is failing to convincethe markets it doesnt seek inflation, in part because in thequest to stomp out deflation once and for all, the FederalReserve is seeking a higher level of inflation. Anotherround of quantitative easing, even at a modest level, sendsthe message the U.S. economy is still in need of stimulus.Short of giving the world a lesson on the Fisher equation(during which it would have to justify paying interest onreserves), the Fed is stuck with the perception it is delib -erately trying to devalue the dollar. Even Japan, which

understands deflation all too well, rescheduled its ownquantitative easing to the same date as the Fed policymeeting in early November in order to offset the expecteddollar decline on the announcement.

The old rule says Dont fight the Fed. That meansthe Fed will engage in QE as long as it deems necessary,and will likely succeed in keeping interest rates low allalong the yield curve. We can think of only one actionthat would offset the seeking-devaluation consensus: FXmarket intervention. The U.S. has not intervened in manyyears, having done so only twice between August 1995 andDecember 2006. At a guess, intervention is not on the table,despite the G20 finance ministers statement that advancedcountries will be vigilant against excess volatility anddisorderly movements in exchange rates in order to helpmitigate the risk of excessive volatility in capital flows fac-ing some emerging countries. Why should the U.S. spendcold, hard cash to help Brazil? Let Brazil impose capitalcontrols. This makes the U.S. a bad citizen in the contextof G20, wanting others to take initiative for the sake of theglobal economy that it wont take itself out of perceivedself-interest. For this fundamental reason, its difficult tosee the dollar rallying anytime soon. Look at the chart of the dollar index again it points resolutelydownward. yFor information on the author, see p. 4.

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SPOT CHECK

Australian dollar/U.S. dollar The Aussie dollar recently pushed above a couple of notable resistance

levels and is now in relatively uncharted territory.

BY CURRENCY TRADER STAFF

In October, the Australian dollar/U.S.dollar pair (AUD/USD) reached 1.000for the first time since July 1982, cap -ping an amazing rebound from itsOctober 2008 low and surpassing itspre-financial crisis high from July 2008(Figure 1).

The pair rallied 22 percent from the

June 4 close of .8231 (the lowest weeklyclose of the late-spring pullback) to theNov. 2 intraday high of 1.0023. Since2000, the Aussie/dollar pair has ral -lied 20-percent or more in a 22-week span 16 other times but 15 of themoccurred in 2009 during consecutiveweeks in the middle of the marketsfurious rebound from the October 2008financial-crisis low, making it difficultto draw any meaningful conclusions

from these moves. (The 16 instances,which concluded the week of Feb. 6,2004, marked the top of an approxi -mately 2.5-year uptrend, and were

followed by afour-month down-swing.) Figure 2shows a weeklychart of AUD/USD, highlightingthe recent run, andthe pairs penetra-

TABLE 1: CONSECUTIVE MONTHLY HIGHS

No. higher highs 1 2 3 4 5 6 7 8 9 10

Occurrences 100 64 31 18 10 5 4 2 2 1

% 64% 48.4% 58.1% 55.6% 50% 80% 50% 100% 50%

The current run of five consecutive higher monthly highs has been equaled 10 other times since 1971,and exceeded 15 other times.

FIGURE 1: MONTHLY AUSSIE/DOLLAR

The AUD/USD pair has pushed to its highest levels in 27 years, and inNovember has posted its fifth consecutive higher monthly high.Source: TradeStation

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tion of the 2009-2010 and 2008 highs.After a brief consolidation, the pair

pushed to a new monthly high inearly November its fifth consecu -tive higher monthly high. Table 1,

which lists runs of higher monthlyhighs up to 10 months long dating back to 1971, shows such moves arerelatively rare. There have been 10other runs of five higher monthlyhighs (followed by a lower monthlyhigh); only 15 runs have been longer(one 11-month run isnt included inthe table). There have been five runsof six consecutive higher monthlyhighs a 50-percent drop-off.

(However, the odds of continuingto a seventh consecutive monthlyhigh were much better four of thefive six-week runs extended anotherweek.) y

For more analysis of the Aussie dollar, seeQE2: Who wins, who loses?

FIGURE 2: WEEKLY AUSSIE/DOLLAR

The AUD/USD pair has exceeded the highs of the past two years after rallying more than 20 percent since early June.Source: TradeStation

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18/3318 October 2010 CURRENCY TRADER18 November 2010 CURRENCY TRADER

In his 1997 book Trading Tactics: An Introduction toFinding, Exploiting and Managing Profitable Share TradingOpportunities , Daryl J. Guppy discussed the application of an indicator he called the Guppy Multiple Moving Average(GMMA), which was based on using groups of movingaverages to better determine trend direction and strength.

The idea is to use several slow moving averages todetermine long-term trend direction, coupled with a groupof faster moving averages to gauge short- and medium-term developments. The goal is to help traders spot trade

opportunities by analyzing the level of interaction and sep -aration between the different mo ving averages, rather thanusing moving average crossovers , as most moving-average

trading systems do.The following analysis explores the idea of using two

groups of moving averages to create a simple system tofollow longer-term trends.

Reviewing the indicator To create a mechanical strategy to trade on the daily timeframe, we will first establish the two groups of movingaverages, as Guppy originally did: The slow group willconsist of the 60-, 50-, 45-, 40-, 35-, and 30-daysimple mov-

ing averages (SMAs) and the fast group will consist of the 15-, 12-, 10-, 8-, 5-, and 3-day SMAs.Figure 1 shows a chart of these averages revealing sev -

eral pieces of information, includingthe longer-term trend direction and thepresence of consolidation periods andsmall countertrend moves highlighted by the shorter averages. However,translating such visual impressions intoa mechanical trading strategy can bedifficult because of the varying rela-tionships between the 12 different mov -ing averages. A simple approach is toevaluate the order of the moving aver-ages and enter trades when they arearranged in such a way that indicatestrends on the long-term, intermediate,and short-term time frames are movingin the same direction.

The trading strategyThe system is a simple set of rulesdesigned to keep you in the marketonly when there is a high degree of certainty regarding trend direction.Long trades are entered when on the

Multiple average

trend-followingTranslating a multi-moving average technique into a mechanical forex-

trading system highlights the benefits of simplicity and diversification.

BY DANIEL FERNANDEZ

TRADING STRATEGIESTRADING STRATEGIES

FIGURE 1: MOVING AVERAGE ALIGNMENT

Trades are signaled when a large group of moving averages (in this case, 12)align in such a way that, in the case of long trades, the short-term averages areabove the longer-term averages.Source for all figures: MetaTrader 4

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above information has been approved and/or communicated by Deutsche Bank AG London in accordance with appropriate local legislation and regulation. Deutsche Bank AG London is regulated for theuct of investment business in the UK by the F inancial Services Authority. Trading in margin foreign exchange can be risky. The use of leverage in foreign exchange trading can lead to large losses as well asgains. Markets referred to in this publication can be highly volatile. For general information regarding the nature and risks of the proposed transaction and types of financial instruments please go to www.

almarkets.db.com/riskdisclosures. This product may not be appropriate for all investors. Before entering into this product you should take steps to ensure that you understand and have made an independentsment of the appropriateness of the product.

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last closed candle all 12 moving averages align in increas -ing order that is, successively shorter moving averagesare above the longer averages e.g., 3-day SMA > 5-daySMA > 8-day SMA > 10-day SMA > 12-day SMA > 15-daySMA > 30-day SMA > 35-day SMA > 40-day SMA > 45-daySMA > 50-day SMA > 60-day SMA. Similarly, short tradesare entered when the averages align in descending order(3-day MA < 5-day SMA < 8-day SMA < 10-day SMA,etc.). Any open trades are closed when the SMAs lose theirproper alignments on the last closed candle.

Figure 2 shows three sample long signals, each oneshorter-term than the preceding trade. All of them areexited before significant price reversals occur. The rules aredesigned to get into the market when directionality is

high (i.e., all moving averageare aligned) and get out quick-ly when the market reverses.To limit losses, all trades arealso protected with a stop-lossof two times th e 20-day aver-age true range (ATR). Tradesize is calculated dynamically based on changes in volatilityand account balance (based ona standard forex lot size of 100,000):

Position size = (0.004 * account balance in USD) /ATR (in pips)

For example, if the cur -rent EUR/USD price is

1.3550, the 20-day ATR is 0.0150, and the account sizeis $10,000, the position size would be 0.26, or $26,000((0.004*10,000)/150), and the stop-loss value would be

1.3250 (1.3550-2* 0.0150). The equation results in risk of roughly 8 percent per trade if the stop-loss is hit. However,it should not cause the system to reach a severe drawdownlevel because the majority of trades will likely be liquidat-ed first by the relatively sensitive exit rule.

The system will be tested on daily data in the Euro/U.S.dollar (EUR/USD), British pound/U.S. dollar (GBP/USD),and Swiss Franc/U.S. dollar (USD/CHF) pairs from June1, 2000 through May 1, 2010, using an initial account sizeof $100,000. Trading costs of 2, 3.5, and 3.5 pips will beassessed for the EUR/USD, GBP/USD, and USD/CHF

pairs, respectively. The tests will be conducted using MetaTrader

4 using data provided byMetaQuotes.

Test resultsThe system was profitable onthe EUR/USD, GBP/USD, andUSD/CHF pairs without anyoptimization or changes in logic(Table 1); the results also showthe EUR/USD pair was the best-performing pair, keeping withits performance in most othertrend-following strategies. This

20 November 2010 CURRENCY TRADER

TRADING STRATEGIES

FIGURE 2: SAMPLE TRADES

The long trades were entered when the averages were in successive order with longest average on bottom and shortest on top, and exited when the averages deviated from thisalignment.

TABLE 1: TEST RESULTS

EUR/USD USD/CHF GBP/USD PortfolioTotal profit 215% 91% 79% 822%

Profit factor 1.82 1.82 1.38 1.56

Avg. compounded yearly profit 12.2% 6.7% 6% 26.3%

Maximum drawdown 27.2% 20.6% 34.2% 45.6%

Number of trades 99 89 76 264

Win % 50.5 43.8 44.7 47

Average profit:loss ratio 1.78 2.33 1.7 1.78

Performance for the three-pair portfolio was better than the sum of its parts.

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superior performance can be attributed to the pairs higherliquidity and more stable trend tendencies, which result infewer whipsaws than in other pairs.

The strategy produces what we would expect from agood long-term trend-following system: a relatively lowtrade frequency, a favorable average profit-to-loss ratio,and a winning percentage close or slightly below 50 per -cent. Also, Figure 3 shows the strategy manifested theextended (one to three years) drawdowns characteristic of this type of trading strategy.

Another aspect of Figure 3 is that the overall portfo -lios equity curve has better characteristics than any of the individual currency pair curves. Because trends anddrawdowns do not always develop at the same time in thethree pairs, the composite performance is smoothed. This,in turn, increases both the total and average compoundedyearly profits, while other system metrics, such as the prof-it-to-loss ratio and winning percentage, are a compromiseof the three individual currency pairs results.

Most importantly, the portfolios maximumdrawdown although larger than that of any of the indi-vidual pairs is not what we would expect from totalingthe three component drawdowns. Because the currency

pairs profit and drawdown periods are not synchronized,the strategy is able to reduce overall risk through diversi-fication.

Simple, effectiveThe systems performancesuggests Daryl Guppys ideato follow trends based on thealignment of a large group of moving averages can be effec-tively translated into a simpletrading strategy, and dem-onstrates that complexity is

not necessary to achieve posi-tive results when developingtrend-following techniques.

The simple base strategyoffers much room for experi-mentation: trading a larger basket of currencies, optimiz -ing the moving averages, orrefining the entry and exitrules to provide a better over-all mathematical expectancy.The strategy also allows trad-ers to diversify, since it can be

applied to different currency pairs which, although theymight not perform brilliantly individually, can provide

much better results as a portfolio.y

For information on the author, see p. 4.

FIGURE 3: EQUITY CURVES

The portfolios profitability was much higher than the sum of the individual currency pairs due to the lack of correlation between their drawdowns.

Related reading

Validating candlestick patterns with tick volumeBy Daniel Fernandez, Currency Trader , October 2010A double-doji breakout strategy gets a boost from a tick-volume filter.

Taking advantage of the Asian trading sessionBy Daniel Fernandez, Currency Trader , June 2010Breaking down the range characteristics of the Asianforex session produces some surprisingly reliable tradingstatistics.

Using dynamic look-back periods in FX systems By Daniel Fernandez, Currency Trader , May 2010

A robust approach to making a trading system dynamicimproves profitability and shrinks drawdowns.

Trend transitions in forexBy Dave Landry, Currency Trader , October 2010Analysis of several transitional patterns, including asimilar multiple moving average approach called the BowTie.

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22/3322 November 2010 CURRENCY TRADER

TRADING STRATEGIESADVANCED CONCEPTS

The yen and

Japanese bond marketsThe idiosyncratic yen appears slightly less exceptional when analysis

adjusts for perma-expectations for higher interest rates in Japan.

BY HOWARD L. SIMONS

As anyone who has traded currencies for more than fiveminutes can attest, the yen is very different from other cur-rencies in its market rhythms (see The yen stands alone,March 2006). Other currencies represent countries in per -manent trade surplus, but many of these are pegged orquasi-pegged to the dollar. Other currencies most certainlyare pushed around by domestic political considerationsand are caught in the bizarre grip of competitive devalu -

ation (see No man is anisland, but the UK is August2010). Other currencies have imperfect links to prospectivereturns on assets (see Currencies and stock index per -formance, April 2008). Other currencies trade as if short-term interest rate arbitrage does not matter, and still othercurrencies, most notably the U.S. dollar and Swiss francare funding currencies for carry trades (see The short,awful life of the dollar carry trade and Franc-ly my dear,

I dont give a carry,August and September2008). It seems as if only the yen combinesall of these qualities tothe extent a reasonabletrader can conclude,The yens not really amarket.

Or is it? While cur-rencies are linked more

to short-term interestrates and movementsthan to capital markets,we should rememberall capital markets arelinked in a giant weband what influences acountrys bond marketmust have a certaininfluence on its cur-rency market, too (seeCurrency carry and

The 10-year Japanese government bond yield and the 10-year swap spread had moved in parallel fashion between the May 2003 low in yields and the onset of the financial crisis in 2007 (greenrectangle). The swap spread has remained static since April 2010 even as bond yields have declined.

FIGURE 1: SWAP SPREADS RENORMALIZING AFTER CRISIS

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23/33CURRENCY TRADER November 2010 23

yield-curve trading, January 2010). Letstake a look at the Japanese bond market andinclude fixed-income volatility and swapspreads in the analysis.

Swap spreadsA swap spread, as a refresher, is what a borrower who is paying a floating rate of interest on a bond will pay to fix those rates.Rising swap spreads thus indicate fear of ris-ing interest rates, and vice-versa. The coursesof 10-year Japanese government bond yieldsand 10-year swap spreads had moved in aparallel manner between the May 2003 lowin yields and the onset of the financial cri-sis in 2007, marked with a green rectangle(Figure 1). Swap spreads have remained stat -ic since April 2010 even as bond yields havedeclined; this stable demand to fix yields can be interpreted as unease with the strength of the Japanese bond rally.

Swap spreads plunged far further andfaster during the height of the crisis in 2008

and early 2009 than10-year JGB yields.Once the crisis passedafter March 2009, swapspreads returned to anormal convergencepath with JGBs.

That observationholds for one tenor, ortime to maturity, forswap spreads. If we go

back to the December16, 2008 date when theFederal Reserve firstmoved to near-0 per -cent short-term interestrates and hinted thatquantitative easingwould be the next step,and the Bank of Japanrestarted quantita-tive easing withoutannouncing it, how

Although the one-year zero-coupon implied volatility in Japan (green axis) is much higher thanthose for longer maturities, Japan also has five-year volatility exceeding 10-year, 30-year, and two-year volatility, in that order a jumbled structure that testifies to the confusion surrounding the anticipated course of Japanese interest rates

FIGURE 3: THE TERM STRUCTURE OF INTEREST-RATE VOLATILITY

While the short end of the yield curve saw fairly constant swap spreads,at the long end swap spreads plunged to negative levels and then roseback toward zero.

FIGURE 2: JAPANESE SWAP SPREADS SINCE DEC. 16, 2008

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has the term structure of swap spreadsadvanced? The short end of the yieldcurve saw fairly constant swap spreads(Figure 2). It was at the long endwhere swap spreads plunged to nega-tive levels and then rose back towardzero. A negative swap spread can beverbalized as, I am so confident inter -est rates are not going to rise you willhave to pay me to fix them. Sometraders just have a mean streak.

Fixed-income volatility

Now lets take a look at fixed-incomevolatility in the Japanese market.Implied volatility readings for zero-coupon Japanese government secu-rities are very different from theirAmerican counterparts. In the U.S.,volatilities tend to decline with matu-rity. While the one-year zero-couponimplied volatility in Japan (markedin Figure 3 with a green axis) is muchhigher than those for longer maturi-

ties, Japan is witness tothe odd spectacle of five-year volatility exceeding10-year, thirty-year andtwo-year volatility, inthat order. This jumbledstructure stands as tes-timony to the confusionsurrounding the expectedcourse of Japanese inter-est rates.

The yield curveThe one aspect of Japanese bond marketsnot subject to confusionin 2010 has been the bull -ish flattening of the yieldcurve (Figure 4). Notehow the short end of theyield curve is lying flatagainst the floor of 0percent like a too-long

ON THE MONEY

24 November 2010 CURRENCY TRADER

ADVANCED CONCEPTS

While the FRR 2,10 has tended to lead two-year zero-coupon volatility by 13 weeks in boththe U.S. and in the Eurozone, the relationship in Japan has ceased to exist. The very steepFRR 2,10 should be leading to greater hedge demand and thus higher volatility for two-year notes, but the Japanese bond options market no longer seems to care.

FIGURE 5: THE YIELD CURVE HAS STOPPED LEADING VOLATILITY

In Japan, just as in the U.S., the mad scramble to get yield, any yield, has pushed investors further out along the maturity spectrum and has forced many to assume bond duration risks they may not understand.

FIGURE 4: JAPANESE YIELD CURVE NOW IN BULLISH FLATTENING

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25/33CURRENCY TRADER November 2010 25

drapery hitting floor, while the long end of the yieldcurve has been moving lower in a classic waterfall fash-ion since April 2010. In Japan, just as in the U.S., themad scramble to get yield, any yield, has pushed inves-tors further out along the maturity spectrum and hasforced many to assume bond duration risks they maynot understand.

We can extract one segment out of this yield curve

surface, the forward rate ratio between two and tenyears. This is the rate at which borrowers can lock inmoney for eight years starting two years from nowdivided by the 10-year rate itself. The more this FRR 2,10 exceeds 1.00, the steeper the yield curve. While theFRR2,10 has tended to lead two-year zero-coupon volatil -ity by 13 weeks, a calendar quarter, very directly in boththe U.S. and in the Eurozone, the relationship in Japanhas ceased to exist (Figure 5). The very steep FRR 2,10

should be leading to greater hedge demand and thushigher volatility for two-year notes, but the Japanese bond options market, like the fictional Rhett Butler, nolonger seems to give a damn.

What we can see, however, is a far more direct rela-tionship between the yen and the FRR 2,10 in Japan. Asthe Japanese yield curve steepens along this key seg-ment of the capital market line, the yen strengthens

(Figure 6). This is a combination of expectations forhigher long-term interest rates in Japan and for higherfixed-income volatility. Both of these elements are pres-ent in many other currencies evaluations, which sug-gests the yen is not as exceptional as it may seem if we just shift the analysis forward in maturity to reflect theperma-expectations for higher interest rates in Japan. yFor information on the author, see p. 4.

As the Japanese yield curve steepens along this key segment of the capital market line, the yen strengthens acombination of expectations for higher long-term interest rates in Japan and for higher fixed-income volatility.

FIGURE 6: THE YIELD CURVE AND THE YEN

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26/3326 October 2010 CURRENCY TRADER26 November 2010 CURRENCY TRADER

CURRENCY FUTURES SNAPSHOT as of 10/29/10

LEGEND:Volume: 30-day average daily volume, inthousands.OI: 30-day open interest, in thousands.10-day move: The percentage price movefrom the close 10 days ago to todays close.20-day move: The percentage price movefrom the close 20 days ago to todays close.60-day move: The percentage price movefrom the close 60 days ago to todays close.The % rank fields for each time window(10-day moves, 20-day moves, etc.) showthe percentile rank of the most recent moveto a certain number of the previous moves of the same size and in the same direction. For example, the % rank for the 10-day moveshows how the most recent 10-day movecompares to the past twenty 10-day moves;for the 20-day move, it shows how the mostrecent 20-day move compares to the pastsixty 20-day moves; for the 60-day move,it shows how the most recent 60-day movecompares to the past one-hundred-twenty60-day moves. A reading of 100% meansthe current reading is larger than all the pastreadings, while a reading of 0% means thecurrent reading is smaller than the previousreadings.Volatility ratio/% rank: The ratio is the short-term volatility (10-day standard deviationof prices) divided by the long-term volatility(100-day standard deviation of prices). The% rank is the percentile rank of the volatilityratio over the past 60 days.

The information does NOT constitute trade signals. It is intended only to provide a brief synopsis of each markets liquidity, direction, and levels of momentum and volatility. See tlegend for explanations of the different fields. Note: Average volume and open interest data includes both pit and side-by-side electronic contracts (where applicable).

BarclayHedge Rankings(as of 9/30/10, ranked by September 2010 return)

Top 10 currency traders managing more than $10 million

Trading Advisor September Return

2010 YTDReturn

$ Under Mgmt.

(Millions)1. Friedberg Comm. Mgmt. (Curr.) 15.60% 56.79% 79.2

2. QFS Asset Mgmt (QFS Currency) 10.62% 18.02% 757.0

3. Silva Capital Mgmt (Cap. Partners) 10.50% 13.20% 18.3

4. IKOS FX Fund 9.20% 29.74% 1111.0

5. Richmond Group (Gl. Currency) 7.16% 1.32% 37.0

6. Harmonic Capital (Gl. Currency) 7.12% 6.66% N/A

7. Greenwave Capital Mgmt (GDS Alpha) 6.92% 7.56% 11.0

8. Greenwave Capital Mgmt (GDS Beta) 5.36% 4.02% 11.0

9. Ortus Capital Mgmt. (Currency) 5.13% 21.16% 1579.0

10. Millennium Global Currency (GBP) 5.11% 4.18% 277.8

Top 10 currency traders managing less than $10M & more than $1M

1. Vaskas Capital Mgmt (Global FX) 6.62% 0.18% 3.8

2. Millennium Global Currency (USD) 4.82% 3.99% 2.5

3. Rove Capital (Dresden) 4.02% 9.55% 2.2

4. King's Crossing Cap'l (FX Model) 2.06% -5.48% 7.5

5. Armytage AAM (Asian Currency) 1.78% -11.59% 3.7

6. BEAM (FX Prop) 1.31% 8.23% 1.7

7. Basu and Braun (Everest Mgd.Accts) 1.13% 10.31% 1.2

8. CenturionFx Ltd 0.89% 6.90% 6.1

9. Drury Capital (Currency) 0.70% -0.19% 3.4

10. KMJ Capital (Currency) 0.47% -0.76% 7.5

Based on estimates of the composite of all accounts or the fully funded subset method.Does not reflect the performance of any single account.

PAST RESULTS ARE NOT NECESSARILY INDICATIVE OF FUTURE PERFORMANCE .

Market Sym Exch Vol OI10-day

move / rank20-day

move / rank60-day

move / rankVolatility

ratio / rank

EUR/USD EC CME 349.4 192.0 -0.47% / 0% 0.84% / 0% 5.41% / 45% .15 / 15%

JPY/USD JY CME 101.6 133.0 1.18% / 20% 3.51% / 79% 6.69% / 54% .13 / 18%

GBP/USD BP CME 108.0 83.8 0.23% / 0% 1.18% / 26% 0.86% / 9% .31 / 85%

AUD/USD AD CME 90.8 133.1 -0.74% / 67% 1.10% / 8% 6.97% / 29% .17 / 15%

CAD/USD CD CME 85.5 106.2 -0.64% / 13% -0.05% / 0% -0.36% / 10% .41 / 40%

CHF/USD SF CME 39.4 52.9 -2.64% / 57% -1.07% / 83% 6.33% / 28% .26 / 93%

MXN/USD MP CME 25.6 125.9 0.75% / 22% 1.80% / 23% 1.73% / 33% .25 / 13%

U.S. dollar index DX ICE 24.1 34.2 0.24% / 20% -1.09% / 16% -3.78% / 16% .15 / 17%

NZD/USD NE CME 6.3 26.4 1.11% / 14% 2.50% / 33% 4.42% / 69% .30 / 62%

E-Mini EUR/USD ZE CME 5.3 5.0 -0.47% / 0% 0.84% / 0% 5.41% / 45% .15 / 15%

Note: Average volume and open interest data includes both pit and side-by-side electronic contracts (where applicable). Price activity isbased on pit-traded contracts.

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INTERNATIONAL MARKETS

28 November 2010 CURRENCY TRADER

CURRENCIES (vs. U.S. DOLLAR)

Rank CurrencyOct. 26

price vs.U.S. dollar

1-monthgain/loss

3-monthgain/loss

6-monthgain/loss

52-weekhigh

52-weeklow Previous

1 Japanese yen 0.01239 4.34% 8.40% 16.45% 0.01243 0.01053 15

2 Euro 1.401485 3.87% 8.57% 4.73% 1.5144 1.1891 33 Australian Dollar 0.993995 3.65% 10.99% 7.17% 1.033 0.8069 24 Swedish krona 0.152315 3.62% 11.29% 9.38% 0.1534 0.1227 15 Indian rupee 0.022545 2.99% 6.60% 0.20% 0.02274 0.02085 106 Thai baht 0.033535 2.90% 8.07% 7.85% 0.03358 0.02938 147 New Zealand dollar 0.75365 2.67% 3.64% 5.12% 0.7641 0.6561 58 Taiwan dollar 0.03267 2.51% 4.85% 3.08% 0.03267 0.03056 119 Singapore dollar 0.77388 2.31% 6.05% 6.06% 0.7747 0.702 9

10 Russian ruble 0.033035 1.93% 0.18% -3.69% 0.03497 0.03077 1711 South African rand 0.144855 1.68% 7.69% 7.36% 0.1478 0.1204 612 Swiss franc 1.030465 1.25% 8.69% 10.55% 1.0566 0.853 413 Brazilian real 0.58661 0.71% 4.06% 3.04% 0.6075 0.5076 814 Chinese yuan 0.150205 0.71% 1.86% 2.57% 0.150400 0.146 1315 Canadian dollar 0.981225 0.49% 1.65% -1.97% 1.0068 0.9195 716 Hong Kong dollar 0.128865 -0.05% 0.09% 0.03% 0.129 0.1281 1617 Great Britain pound 1.57416 -0.53% 2.07% 2.36% 1.6877 1.4235 12

GLOBAL STOCK INDICES

Country Index Oct. 26 1-monthgain/loss3-monthgain/loss

6-monthgain loss

52-weekhigh

52-weeklow Previous

1 Mexico IPC 35,373.39 6.80% 7.33% 4.74% 35,429.20 28,263.00 12

2 Hong Kong Hang Seng 23,601.24 5.64% 13.25% 9.33% 23,866.90 18,971.50 2

3 Germany Xetra Dax 6,613.80 5.33% 6.77% 4.45% 6,668.54 5,312.64 10

4 South Africa FTSE/JSE All Share 30,133.78 4.06% 5.74% 2.81% 30,439.46 25,793.06 3

5 Canada S&P/TSX composite 12,684.68 4.05% 7.99% 3.29% 12,710.20 10,745.20 14

6 U.S. S&P 500 1,185.64 3.81% 6.33% -2.18% 1,219.80 1,010.91 57 Italy FTSE MIB 21,363.52 3.74% 2.61% -6.23% 24,059 18,045 13

8 Brazil Bovespa 70,740.39 2.80% 6.47% 2.71% 72,140.00 57,634.00 11

9 UK FTSE 100 5,707.30 2.40% 6.66% -0.81% 5,833.70 4,790.00 7

10 France CAC 40 3,852.66 2.30% 5.95% -3.62% 4,088.18 3,287.57 4

11 Switzerland Swiss Market 6,476.60 2.17% 4.47% -4.81% 6,990.70 5,935.00 15

12 Singapore Straits Times 3,162.51 1.58% 6.59% 5.33% 3,220.71 2,605.10 9

13 Australia All ordinaries 4,761.50 0.83% 5.71% -3.09% 5,048.60 4,194.40 6

14 India BSE 30 20,221.39 0.52% 12.22% 13.95% 20,854.60 15,330.60 1

15 Japan Nikkei 225 9,377.38 -2.35% -1.33% -16.02% 11,408.20 8,796.45 8

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NON-U.S. DOLLAR FOREX CROSS RATES

nk Currency pair Symbol Oct. 26 1-monthgain/loss3-monthgain/loss

6-monthgain loss

52-weekhigh

52-weeklow Previous

Euro / Pound EUR/GBP 0.89031 4.43% 6.37% 2.34% 0.9239 0.8065 5

Yen / Real JPY/BRL 0.021125 3.63% 4.17% 13.03% 0.02127 0.01838 19

Euro / Canada $ EUR/CAD 1.428305 3.37% 6.81% 6.84% 1.5983 1.2502 11Aussie $ / Canada $ AUD/CAD 1.013015 3.14% 9.18% 9.32% 1.0134 0.8643 4

Euro / Real EUR/BRL 2.3842 2.93% 4.12% 1.44% 2.6379 2.1772 10

Aussie $ / Real AUD/BRL 1.694485 2.91% 6.65% 4.01% 1.6982 1.4954 3

Euro / Franc EUR/CHF 1.36004 2.59% -0.10% -5.26% 1.5173 1.2763 13

Aussie $ / Franc AUD/CHF 0.96461 2.31% 2.12% -3.05% 1.0079 0.8949 9

Aussie $ / New Zeal $ AUD/NZD 1.31891 0.95% 7.10% 1.96% 1.3233 1.2088 8

Franc / Canada $ CHF/CAD 1.05018 0.76% 6.92% 12.77% 1.0657 0.8989 15

Euro / Aussie $ EUR/AUD 1.40995 0.22% -2.12% -2.28% 1.6627 1.3633 18

Canada $ / Real CAD/BRL 1.672715 -0.22% -2.32% -4.86% 1.8244 1.6003 16

Euro / Yen EUR/JPY 113.095 -0.46% 0.15% -10.06% 138.473 105.404 2

Aussie $ / Yen AUD/JPY 80.225 -0.67% 2.42% -7.98% 88.048 72.0981 1

Pound / Canada $ GBP/CAD 1.604285 -1.01% 0.41% 4.42% 1.7882 1.4894 17

New Zeal $ / Yen NZD/JPY 60.815 -1.62% -4.41% -9.76% 69.5279 58.9096 7

Pound / Franc GBP/CHF 1.527595 -1.76% -6.11% -7.42% 1.7112 1.5097 20

Franc / Yen CHF/JPY 83.15 -2.98% 0.31% -5.07% 91.549 76.36 6

Canada $ / Yen CAD/JPY 79.18 -3.71% -6.23% -15.84% 94.1955 79.0966 12

Pound / Aussie $ GBP/AUD 1.58367 -4.03% -8.03% -4.49% 1.8296 1.58367 21

Pound / Yen GBP/JPY 127.07 -4.65% -5.78% -12.07% 151.731 126.422 14

GLOBAL CENTRAL BANK LENDING RATES

Country Interest Rate Rate Last change April-10 Oct-09

United States Fed funds rate 0-0.25 0.5 (Dec. 08) 0-0.25 0-0.25

Japan Overnight call rate 0 0.1 (Oct. 10) 0.1 0.1

Eurozone Refi rate 1 0.25 (May 09) 1 1

England Repo rate 0.5 0.5 (March 09) 0.5 0.5Canada Overnight funding rate 1 0.25 (Sept 10) 0.25 0.25

Switzerland 3-month Swiss Libor 0.25 0.25 (March 09) 0.25 0.25

Australia Cash rate 4.5 0.25 (May 10) 4.25 3.25

New Zealand Cash rate 3 0.25 (July 10) 2.5 2.5

Brazil Selic rate 10.75 0.5 (July 10) 8.75 8.75

Korea Overnight call rate 2 0.5 (Feb. 09) 2 2

Taiwan Discount rate 1.25 0.25 (Feb. 09) 1.25 1.25

India Repo rate 6 0.25 (Sept 10) 5,25 4.75

South Africa Repurchase rate 6.5 0.5 (Mar. 10) 7 7

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30/3330 November 2010 CURRENCY TRADER

INTERNATIONAL MARKETS

Unemployment Period Release date Rate Change 1-year change Next release

AMERICASArgentina Q2 8/23 7.9% -0.4% -0.9% 11/22Brazil Sept. 10/21 6.2% -0.5% -1.5% 11/25Canada Sept. 10/8 8.0% -0.1% -0.3% 11/5

EUROPEFrance Q2 9/2 9.3% -0.2% 0.2% 12/2Germany Sept. 10/28 6.7% -0.1% -0.9% 11/30UK May-July 9/15 7.8% -0.1% -0.1% 11/17

ASIA andS. PACIFIC

Australia Sept. 10/7 5.1% -0.1% -0.6% 11/11HongKong July-Sept. 10/19 4.2% 0.0% -1.2% 11/16Japan Aug. 10/1 5.1% -0.1% -0.1% 11/1Singapore Q2 7/30 2.3% 0.1% -0.9% 10/29

GDP Period Release date Change 1-year change Next release

AMERICASArgentina Q2 9/17 23.9% 12.8% 12/17Brazil Q2 9/3 1.2% 9.0% 12/9Canada Q2 8/31 0.7% 6.7% 11/30

EUROPEFrance Q2 8/13 0.7% 6.7% 11/30Germany Q2 8/13 2.3% 4.9% 11/12

UK Q2 9/28 1.4% 5.8% 12/22AFRICA S. Africa Q2 8/24 -4.4% -4.7% 11/30

ASIA and S.PACIFIC

Australia Q2 9/1 0.9% 3.2% 12/1Hong Kong Q2 8/13 0.4% 6.5% 11/12India Q2 8/31 19.1% 8.8% 11/30Japan Q2 8/16 0.1% 0.4% 11/15Singapore Q2 8/27 7.8% 18.8% NLT 11/26

CPI Period Release date Change 1-year change Next release

AMERICASArgentina Sept. 10/15 0.7% 11.1% 11/12Brazil Sept. 10/7 0.5% 4.7% 11/9

Canada Sept. 10/22 0.2% 1.9% 11/23

EUROPEFrance Sept. 10/13 0.1% 1.6% 11/10Germany Sept. 10/12 -0.1% 1.3% 11/9UK Sept. 10/12 0.0% 1.1% 11/16

AFRICA S. Africa Sept. 10/27 0.1% 3.2% 11/24

ASIA andS. PACIFIC

Australia Q3 10/27 0.7% 2.8% 1/25Hong Kong Sept. 10/21 0.3% 2.6% 11/22India Sept. 10/29 0.0% 9.9% 11/30Japan Aug. 10/1 0.3% -0.9% 11/1Singapore Sept. 10/25 0.0% 3.7% 11/23

PPI Period Release date Change 1-year change Next release

AMERICASArgentina Sept. 10/15 0.9% 15.1% 11/12Canada Aug. 9/29 0.4% 0.6% 10/29

EUROPEFrance Sept. 10/28 0.1% 1.6% 11/30Germany Sept. 10/20 0.3% 3.9% 11/19UK Sept. 10/8 0.3% 4.4% 11/5

AFRICA S. Africa Sept. 10/28 -4.1% 6.8% 11/25

ASIA andS. PACIFIC

Australia Q3 10/25 1.3% 2.2% 1/24Hong Kong Q3 9/13 2.1% 5.9% 12/13India Sept. 10/14 0.2% 5.4% 11/14Japan Sept. 10/14 0.0% -0.1% 11/11Singapore Aug. 9/29 -0.1% -1.5% 10/29

As of Oct. 28, 2010 LEGEND: Change: Change from previous report release. NLT: No later than. Rate: Unemployment rate.

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31/33CURRENCY TRADER November 2010 31

ACCOUNT BALANCE

Rank Country 2009 Ratio* 2008 2010+

1 Singapore 32.387 17.773 35.815 44.4812 Norway 49.58 13.096 79.885 68.5723 Taiwan Province of China 42.916 11.338 27.505 42.6394 Hong Kong SAR 18.278 8.68 29.296 18.8995 Switzerland 41.697 8.476 10.234 50.004

6 Sweden 29.43 7.247 37.279 26.4397 Netherlands 42.702 5.36 41.978 44.0248 Korea 42.668 5.125 -5.776 26.0419 Germany 163.256 4.89 245.722 200.188

10 Japan 141.751 2.796 157.079 166.46311 Belgium 1.333 0.282 -14.891 2.32112 United Kingdom -24.259 -1.113 -44.063 -50.3113 Czech Republic -2.146 -1.128 -1.255 -2.35814 United States -378.434 -2.68 -668.856 -466.51315 Canada -38.075 -2.85 6.483 -44.245

16 Ireland -6.705 -3.015 -13.886 -5.58217 Italy -67.151 -3.17 -78.874 -58.27218 Australia -43.693 -4.395 -47.477 -29.82819 Spain -81.198 -5.532 -155.962 -71.92

Totals in billions of U.S. dollars *Account balance in percent of GDP +EstimateSource: International Monetary Fund, World Economic Outlook Database, October 2010

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EVENTS

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32/3332 November 2010 CURRENCY TRADER

The information on this page issubject to change. Currency Trader is not responsible for the accuracyof calendar dates beyond presstime.

CPI: Consumer price indexECB: European Central BankFDD ( rst delivery day): The rstday on which delivery of a com-modity in ful llment of a futurescontract can take place.FND ( rst notice day): Alsoknown as rst intent day, this isthe rst day on which a clear -inghouse can give notice to abuyer of a futures contract that itintends to deliver a commodity inful llment of a futures contract.The clearinghouse also informsthe seller.FOMC: Federal Open MarketCommitteeGDP: Gross domestic productISM: Institute for supply

managementLTD (last trading day): The nalday trading can take place in afutures or options contract.PMI: Purchasing managers indexPPI: Producer price index

Economic Releaserelease (U.S.) time (ET)GDP 8:30 a.m.CPI 8:30 a.m.ECI 8:30 a.m.PPI 8:30 a.m.ISM 10:00 a.m.

Unemployment 8:30 a.m.Personal income 8:30 a.m.Durable goods 8:30 a.m.Retail sales 8:30 a.m.Trade balance 8:30 a.m.Leading indicators 10:00 a.m.

GLOBAL ECONOMIC CALENDAR: NOVEMBER

November 2010

31 1 2 3 4 5 67 8 9 10 11 12 13

14 15 16 17 18 19 2021 22 23 24 25 26 2728 29 30 1 2 3 4

123 U.S.: October ISM manufacturing

report and FOMC interest-rate

announcement4 UK: Bank of England interest-rate

announcement

5 U.S.: October employment reportCanada: October employment report

UK: October PPI

ECB: Governing council interest-rate

announcement

LTD: November U.S. dollar index

options (ICE)

6789 Brazil: October CPI

Germany: October CPI

Mexico: Oct. 31 CPI and October

PPI

10 U.S.: September trade balanceBrazil: October PPI

France: October CPI

11 Australia: October employmentreport

Japan: October PPI

12 France: Q3 GDPGermany: Q3 GDP

13

14 India: October PPI15 U.S.: October retail sales

Japan: Q3 GDP

16 U.S.: October PPIHong Kong: August-October em-

ployment report

Japan: Bank of Japan interest-rate

announcement

UK: October CPI

17 U.S.: October CPI and housingstarts

UK: September employment report

18 U.S.: October leading indicators

19 Germany: October PPILTD: November forex options

2122 Hong Kong: October CPI

Mexico: Q3 GDP

23 Canada: October CPISouth Africa: Q3 GDP

24 U.S.: October personal income anddurable goods

Mexico: Nov. 15 CPI

South Africa: October CPI

25 Brazil: October employment reportMexico: October employment report

South Africa: October PPI

26 Japan: October CPI2728

29 Canada: October PPI30 Canada: Q3 GDP

France: October PPI

Germany: October employment

report

India: Q3 GDP and October CPI

Japan: October employment report

December

1 U.S.: Fed beige book and November ISM manufacturing report

Australia: Q3 GDP

2 France: Q3 employment report3 U.S.: October employment report

LTD: December U.S. dollar index

options (ICE)

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XXXXXXFOREX TRADE JOURNAL

TRADE

Date: Friday, Oct. 29, 2010.

Entry: Long the Australian dollar/U.S.dollar (AUD/USD) at .9795.

Reason for trade/setup: With thepair having recently surpassed its late-2008 high and hitting 1.0000 for the first time since 1982,it might not appear to be the best time to attempt a longtrade. However, after a roughly three-week consolidation/pullback, the pair has twice bounced off established sup-port around .9650, and further near-term U.S. dollar weak -ness looms in reaction to renewed quantitative easing by

the Federal Reserve. The question: Has the market alreadypulled back enough, or is it likely to retrace a larger por-tion of the September-October rally before making anotherupside run? (This was a paper trade.)

Initial stop: .9654. Raise stop to breakeven on a moveabove .9870.

Initial target: .9930. Take partial profits and raise stop.

RESULT

Exit: .9930.

Profit/loss: .0135.

Outcome: The market made a favorable move whentrading resumed on Nov. 1, rallying to .9914 (.0017 shy of the initial profit target) and triggering an upward adjust-ment of the stop to .9802. The pair pulled back to around

.9830 intraday, forming an obvious chart support level afair distance above the stop.The next day, the pair made a serious jump, blasting

through the initial target and reclaiming the 1.000 level.The stop was then raised to .9895, thus locking in .0100profit (less commissions) on the remainder of the trade. y

Note: Initial trade targets are typically based on things such as the historical per-

formance of a price pattern or a trading system signal. However, because individ-

ual trades are dictated by immediate circumstances, price targets are fexible and

are often used as points at which to liquidate a portion of a trade to reduce expo-

sure. As a result, initial (pre-trade) reward-risk ratios are conjectural by nature.

Buying high and looking higher.

Source: TradeStation

TRADE SUMMARY

Date Currencypair Entryprice

Initialstop

Initialtarget IRR Exit Date

P/LLOP LOL Tradelengthpoint %

10/29/10 AUD/USD 9795 9654 9930 0 96 9930 11/2/10 0135 1 38% 0211 0008 2 d