Currency trading by its sheer nature carries high risks. It takes time to understand not just what influences price action, but the potential volatility that one pair has over another.
Therefore, when determining a strategy, traders need to look at the potential volatility and event risk that comes with a currency, and also how active they would be in the market.
Long EUR/CHF and USD/JPY
Two currencies which may have upside, but are low risk/volatility plays are long EUR/CHF and USD/JPY. We are not overly bullish on the USD, given that the FOMC recently suggested the 'economic condition is likely to warrant exceptionally low levels for the Federal Funds Rate at least through late 2014', and that it could 'adjust' its security holdings 'to promote a stronger economic recovery'. However, the improvement in US data has been noticeable, and price action encouraging, with the pair breaking above the June 2007 downtrend. Interestingly, price action now looks remarkably like what we saw in August 1995, four months after the trend low was posted; USD/JPY broke above the five-year downtrend and never looked back. Our call on USD/JPY would largely be hindered by heightened expectations of QE3; however, this could be offset by being long AUD/USD, while looking to exit if it traded below the January low of 76.33.
EUR/CHF is also a low volatility pair, and we feel the Swiss National Bank (SNB) will do all it can to defend the 1.20 peg. If this peg fails, it would translate into huge forex losses for the Central Bank, so it will do all that is necessary; recent commentary from the Swiss Finance Minister that he sees EUR/CHF fair value at 1.40 also adds weight to this call. Being long EUR/CHF with a stop loss below 1.20 could be a reasonably low-risk play, and there is still a chance the SNB may lift the floor to 1.25 and even 1.30 this year to help make its exporters more competitive.
Short EUR/AUD, EUR/NZD and EUR/CAD
At the beginning of the year, we felt selling EUR/AUD, EUR/NZD and EUR/CAD were the standout trades, and we still do. All three commodity currencies have huge appeal, especially if the Fed does go down the road of QE3 and China employs pro-growth measures. These crosses will also clearly benefit from higher commodity prices, and we have seen reserve managers looking to diversify in recent times out of euros and USDs by buying them. Australia and Canada both have a solid banking industry and are two of thirteen nations left with AAA ratings and liquid bond markets. On the other hand, Europe still has poor growth prospects and huge debt/deficit issues, with the ECB likely to combat this by cutting another 25 basis points off its refinancing rate, while continuing to increase its balance sheet; as a result we feel the euro will continue to be used as a funding currency. Ultimately, a move to 1.19 by year-end on EUR/AUD and 1.2550 on EUR/CAD could be on the cards; however it will not go down in a straight line, so selling correctional bounces may be the best strategy. This would involve traders being more active and having an understanding of technical analysis. We premise the higher risk here on the ability to time the moves, but as with all trades, stop losses would protect the downside.
The resilient AUD/USD
As previously mentioned, the buoyancy of AUD/USD has been impressive, given the downside risks to global growth. The Australian ten-year treasury is yielding an attractive four percent, despite the swaps market pricing in four rate cuts over twelve months. The recent break of the July downtrend is positive, and we would not rule out a move above the July 27 high of 1.1081, although we would be using pullbacks as buying opportunities, while looking to take potential profits at key levels such as 1.0765 (September 1 pivot high). On a longer-term basis, we feel the pair could test the all-time high of 1.1081, and perhaps even 1.15 depending on Fed action.
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Updated 01/02/2012
Disclaimer: IG Markets provides an execution-only service. The material above does not contain (and should not be construed as containing) personal financial or investment advice or other recommendations, or an offer of, or solicitation for, a transaction in any financial instrument. No representation or warranty is given as to the accuracy or completeness of the above information. Consequently any person acting on it does so entirely at his or her own risk. The research does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. IG Markets accepts no responsibility for any use that may be made of these comments and for any consequences that result.
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