ForexSpirit

The month of October ended with market razzmatazz that only a Fed interest rate decision can produce. Bernanke and crew dipped into their trick or treat pumpkin and handed the market a nice sweet, but not too sweet, 25 basis point reduction.

The euro didn’t quite know how to deal with the announcement at first. The move had been widely anticipated in advance and had thus been largely factored into the price already. After a bit of dithering there was a quick push up to the 1.45 handle. The 1.45 level has long been regarded as a target price for the euro and there was no surprise in seeing it act as a strong resistance level.

In the run-up to the Fed announcement on Wednesday I closed out a Q4 bread and butter trade at 1.4416. I was also able to capitalise on the spike up to 1.45 as I had a profit taking limit order on a Q3 trade placed at 1.4497. This Q3 trade had been opened a week earlier on October 23rd and it netted a nice 249 pips in total. During the past week while I held onto that trade I placed an additional two other successful bread and butter trades.

The strong euro trend produced some nice results during that period. On the other hand, yen has been slightly trickier to deal with. And by trickier I of course mean that I haven’t been able to make any money from it since the large drop that ended on October 21st.

I finished the month with three loses on USD-JPY. I closed out the position I had opened at 113.47 on October 21st once price broke above the weekend gap at 114.63 (as I said I would do in my journal post at the time).

It was a while before I decided to jump back into USD-JPY. I have been looking to react to events that focus on matters relating to the credit crunch; this mainly ends up being poor earnings reports from the big investment banks and continued poor news out of the mortgage and housing industries.

I was back in on October 24th with a Q3 short entry at 113.85. That trade ambled slowly nowhere but I held onto it as price seemed stuck in the 114 area. I added to that entry with another Q3 at 114.50 last Monday when news was released on the poor results by Merrill Lynch that ended up being far worse than originally forecast.

There was very little unwinding of the carry trade this time around compared to what we saw in August. In fact the carry trade looked like it was was completely business as usual on USD-JPY (it was slightly more volatile on the yen crosses). Going into the Fed rate announcement where a 25 basis point cut was expected I decided to bail out of my two yen trades. If the markets got their 25 basis point cut I postulated that the US equity markets would rally at their good fortune. This is indeed what happened on Wednesday and USD-JPY continued on its merry way almost up to the 116 level.

Of course, things went slightly haywire on Thursday when the DOW dropped 362 points based on poor earning from ExxonMobil, and Citigroup, one of the big investment banks, came out with poor results, once again due to the credit crunch and mortgage woes. Before I knew it I had both my Q3 yen trades back on. If I had realised the impact that the Citi group earnings were going to have on the market before the US stock markets opened I would have been back in at the same price that I closed the trades out the day before. Unfortunately, I was a bit slow off the mark and I ended getting back in 40 pips below my prior exit price.

Today’s NFP release was a real rodeo ride! The employment number came in at over twice the expected number (82,000) at 166,000. After yesterday’s strong GDP reading of 3.9% for the third quarter it looked like the stock markets should rally on all the good news. If this was going to be the case then USD-JPY should see itself heading back on its way to 116 and above. My feeling was that the credit worries from the previous day would linger around to spoil the party.

The DOW opened up positive based off the NFP number but was soon underwater. It traded most of the day in the red, generally stuck between -50 and -100 points. It did manage to almost break into positive territory mid-day but dipped under once again. The plunge protection team wasn’t going to allow another negative close to be on the cards so the final hour of stock trading saw the DOW up 27 points at the close.

Why am I going on about the DOW when I trade currencies? The US equity markets are a key gauge as to the health of the carry trade. If the equity markets go south then investors are going to take their carry trades off the table. In simple terms, a sharp plunge in the US equity markets will cause the carry trade pairs (of which USD-JPY is one) to unwind. This is why I am interested in what is going on with the DOW market in light of my short USD-JPY positions.

The up and down nature of the DOW market was eerily reflected in USD-JPY, which just couldn’t seem to make up its mind if it wanted to go up or down. It pretty much just ended up at the Friday close where it had started off in the morning.

At the time of the actual NFP release at 8:30 EST there were some dollar bulls in the market trying to get things going. They were soon overrun, especially on the other main currency pairs, EUR-USD and GBP-USD. I have also started to keep an eye on AUD-USD as it makes it way to potentially reaching parity.

When I saw the dollar bulls being crushed I jump in with a Q4 trade on EUR-USD at 1.4470 and dipped my toe in for the first time on AUD-USD with a Q4 entry as well. When the US equity markets opened and the DOW turned negative I was wary that we might have another classic carry trade unwind scenario in progress. When the carry trade pairs unwind it is not uncommon to see the dollar rally in non-carry trade pairs such as EUR-USD and AUD-USD. I didn’t want to see my USD-JPY trades go into profit while my other two entries (in Euro and Aussie) went south. I decided to go with the carry unwind scenario as the most likely outcome for the day and so closed my two non-USD-JPY trades. I managed to close out my euro trade for 5 pips profit. My AUD-USD trade was not so lucky. It lost 90 pips.

I’ve already related how the markets then became rangebound all day. EUR-USD ended up finding its legs again and closed out the week above the 1.45 handle. AUD-USD was similar; it pulled back and finished out the week just where I’d placed my entry earlier that day. If I’d held both my trades in these pairs open I’d have made a few pips instead of losing some.

The unwinding of the carry trade can be brutal and quick, as was witnessed in August. If the unwinding had taken place as I thought it might then my decisions would all be all roses right now.

What I have to do now is ponder over the weekend if I think there is a strong possibility that the carry trade unwind scenario is still on. Does today’s DOW rebound at the close signal a continued recovery in the equity markets for early next week? Or will the feel-good news be seen through for what it is, and the market will go back into sell mode based on the tumbling financial stocks?

Time to get the thinking cap on again.