Global

Below is a chart of the historical Central Bank interest rates for Europe (EUR), Switzerland (CHF), United States (USD), Australia (AUD), and Japan (JPY) from 2000 to 2010. From this comparison, many basic observations can be made. Note that rising or falling interest rates have generally been extremely consistent in direction and typically have continued for two or more years. Other general observations from this comparison show that the European rate has always been anywhere from 2.25% to 0.75% higher than the Swiss rate; that the Australian rate has mostly remained the highest; that the Japanese rate has by far always remained the lowest; that all the rates generally remain closely correlated in direction but not in amplitude; and that United States or Australia many times leads new cycles in interest rate hikes or cuts. All things considered, these are only generalizations that seem likely to continue into the future, but they are not necessarily guaranteed to always remain true. 

Also, carefully note that the Australian interest rate has just recently begun to experience a series of gradual interest rate hikes, while the other nations have all recently stopped cutting their interest rates, with most being at or near record lows.

The currency pair with highest interest rate differential has usually been and still is AUD/JPY. Although other economic data must also be considered, a currency pair with a relatively high and steadily expanding interest rate differential fueled by interest rate hikes, greatly favors appreciating the price of the higher interest rate currency in the pair. This is demonstrated in the monthly chart of AUD/JPY above. You can see that during the entire 2002 – 2008 period of the gradually rising Australian interest rate, the price of AUD/JPY also gradually appreciated. Holding onto an AUD/JPY position during this period, you would have not only earned a high interest rate, but also your position would have appreciated in value more than 50%, making this a very profitable long-term carry trade. 

It is important to consider that, historically, higher interest rate differential currency pairs are more volatile. Therefore, after an extended period of strength fueled by a rising interest rate, the higher interest rate currency may rapidly start to depreciate, possibly giving up a significant amount of its prior gains. More importantly, this usually occurs even before any interest rate cuts actually occur, as demonstrated in the comparison of the Australian interest rate vs. AUD/JPY. Therefore, it is not always possible to closely time the best entry and exit of a carry trade just by an interest rate hike or cut alone, because the interest rate number itself is already highly anticipated. The actual wording of the statement is usually just as or more important than the decided interest rate, because it contains the collective outlook on the economy and intentional hints about future monetary policy. Therefore, when implementing a carry trade strategy, it is important to carefully read the actual wording of interest rate decisions and not just look at the interest rate number alone. It is also important to generally consider how much of the outlook the market has already priced into the current value of the currency.

The earned interest of a held currency pair position is typically referred to as swap. Swap is primarily correlated to the interest rate differential, but is also affected by many other factors. It is important to mention that a large majority of retail fx brokerages do not offer the highest available swap rates, this could affect the amount of interest you earn (or pay) up to a factor 10 depending on which brokerage you choose. This could be an advantage or disadvantage depending on your strategy, but is clearly a major disadvantage for carry trades intended to capitalize on earned interest. If your fx brokerage does not offer swap rates comparable to their corresponding Central Bank interest rate differential, then it is not ideal for executing a carry trade strategy. As an example, at a brokerage offering premium swap, currently holding onto a long position of one 10K mini-lot of AUD/JPY (valued at $ 8,662 (USD)) earns an incredible variable rate of $ 5.88 (USD) a day.

The recent series of articles on ResearchReloaded.com regarding the U.S. dollar and Swiss franc have accurately timed and forecasted the growing strength of the dollar. It all started as an expected bounce off short-term support just a couple days before the Dec 4th U.S. Non-Farm Payrolls (NFP), when price was still only at 0.9987. It then developed into a major break out upon the Dec 4th positive jobs data surprise, and is still now continuing to follow through with a strong trend, currently at a price of 1.0428. For the Swiss franc, this was a relatively large move in a short period of time. For example, if you had opened a single contract of the Swiss franc on the futures market (prefix SF on the CME), which requires an initial margin of under $4,000 (USD), then you would now be holding onto a net profit of $5,100.21.

Although we have specifically focused on U.S. dollar vs. Swiss franc tracked by the USD/CHF currency pair, the same dollar strength occurred accross the board within all the major currency pairs, including USD/JPY. However, the highest degree of correlation between any two currency pairs exists between USD/CHF and EUR/USD, with a consistent correlation of 97% - 99%, as highlighted in this article on currency correlations. 

This fact is made very apparent in the daily charts below, where EUR/USD appears to be an almost exact mirror image of USD/CHF. In fact, USD/CHF is commonly used as a leading indicator of EUR/USD, and vice versa. Therefore, you could have just as easily instead went short on EUR/USD, rather than long on USD/CHF, and produced a similar profit. The major advantage of EUR/USD over USD/CHF is its much higher liquidity and tighter spreads, which is not as critical for longer-term trades. However, the disadvantage in the spot fx market of shorting EUR/USD rather then going long on USD/CHF would have been paying the current Central Bank Rate differential of 0.75% to hold your position, whereas for USD/CHF it is 0%.

In the daily USD/CHF chart below, you can see that the upward trend of the dollar has continued. Technically speaking, the important developments that occurred were that ADX finally crossed above 25 into trend territory and is still steeply sloping up, strongly sustained by the blue +DMI still maintaining above ADX. Furthermore, for the first time since last March, the 20 day moving average crossed above the 50, such that now the 5, 10, 20 and 50 day moving averages are all aligned, indicating strong longer-term U.S. dollar bias. This trend is now definitively established, and although short-term retracements are possible, the longer-term outlook is still for U.S. dollar strength, with it most likely to make yet higher highs. The next level of significant horizontal resistance that USD/CHF is aiming for resides near 1.0600.

Also, this week's U.S gross domestic product and durable goods data for November should stimulate more volatility in the USD/CHF and EUR/USD pairs.

USD/CHF is currently near parity (1.0000), resting near the bottom of recent daily trading range. I'm expecting at least a temporary increase in USD strength vs. CHF ahead of Friday's positively anticipated U.S. Non Farm Payrolls.

See below. Note that bottom of range is backed by the green lower Bollinger Band of the 4 hour chart as well as the daily chart.

Stochastics and CCI are both oversold.

Also, ADX still indicates price is most likely to remain within recent range, expected to traverse upwards for at least the short-term from its current oversold support.

However, for the longer-term, the 200, 50, 20, 10, and 5 period moving averages are all aligned and descending, hinting that the current short-term range actually resides within a longer-term trend of CHF strength vs. USD weakness. The dollar is still weak in the longer-term.

In an email note, Charles de Trenck of research firm Transport Trackers highlights how shipping companies could face substantial write-downs. In a similar fashion to banks right now, some of their assets are being carried on the balance sheet at far higher values than the current market value. So expect their balance sheets to be far worse than they look right now.

Transport Trackers: Brokers have highlighted a new all-time low for container charter rates this week (and the BDI traded back below 4,000...psychology playing its role here both on up and down sides...though some tankers did better this week).

One of our main worries for 2010 is impairments of value on balance sheets for many ship classes delivered in recent years -- ONCE ACCOUNTANTS perform their duty-bound functions. Many banks, often European, will face same/similar issues on their loan books as well.

The damage will likely be to containers first, but some bulk will likely also take a hit. ... Another way to slice the distribution of troubles is by geography. In some geographies there are total bailouts, while in others there are few. Japan is getting hard hit at the moment.

Wholesale impairments on B/S have not happened in many decades. In the 80s it was bankruptcies after sometimes long drawn out dramas. ...How will it play out this time? Over the last year the HR index has declined some 74% -- and from peaks the declines are still a bit more.