Q&A
Futures For You
Inside The Futures World
Want to find out how the futures markets really work?
DeCarley Trading senior analyst and broker Carley Garner responds to your questions
about today’s futures markets. To submit a question, post your question
at https://Message-Boards.Traders.com. Answers will be posted there, and selected questions will appear in a future issue of S&C. Visit Garner at www.DeCarleyTrading.com. Her books, Commodity Options and A Trader’s First Book On Commodities, are available from FT Press.
PROFIT FROM INTERVENTION?
Now more than ever, currency traders have been affected by government intervention. Is there a way to profit?
The term “intervention” is used to describe a scenario in which a person or entity interferes with a situation in an attempt to alter or hinder the natural development of circumstances. As far as some central banks are concerned, currency traders are not unlike some types of addicts; they find a substance or action that provides short-term gratification without regard to the big picture or the long-term effects of their actions.
So if traders long the Swiss franc compared to the US dollar experience relatively stress-free and relentless profits, they will continue with that currency until something dramatic changes. This is what happened in early September 2011.
In many instances, trends in the currency markets extend beyond what is fundamentally feasible and such speculative moves cause frustration among central bankers. Their problem primarily stems from the assumption that higher currency valuations result in less attractive goods and services to the outside world. Accordingly, due to less demand for exports, a weak currency can be a drag on economic growth. Thus, central bankers sometimes believe intervening in the currency markets by directly coercing currency exchange rates is the only solution to leveling the playing field.
Currency intervention to control price is done indirectly through the manipulation of imports and exports, or directly by the purchase or sale of large amounts of currency by central banks in the open market. If this seems unfair to those speculating in the markets, it is. Nonetheless, there are other agendas at play; in the overall scheme of things, speculators are at the bottom of the importance ladder when it comes to government behavior. Unfortunately, this is something that must be understood, and accepted, by anyone wishing to trade currencies.
One of the most consistent interventionists is Japan. In mid-2003, after a nearly 14-year period of deflation and economic anemia, the Japanese central bank essentially printed 35 trillion yen to purchase about $320 billion in US dollars. More recently, in March 2011, the Japanese central bank made a similar attempt to cap a rally in the yen against the US dollar. This time, it was actually a group composed of seven of the world’s most influential central banks that intervened in what are normally free-floating currency markets.
The Usd/Jpy was trading at an all-time low near 76.00 (equivalent to an all-time high in the futures market near 129.50). Because the astronomical yen valuation threatened the ability of the Japanese economy to snap back from the catastrophic March 11, 2011, earthquake, the G7 coordinated an operation in which each of the participating nations sold large amounts of yen at the open of their respective trading day beginning with the Bank of Japan (Boj). In similar actions, the Boj sold large amounts of yen on the open of the Asian market trade on August 4, 2011.
In early September 2011, the Swiss National Bank (Snb) took the concept of manipulation to an extreme by stating they would “no longer tolerate” the Eur/Chf (euro versus Swiss franc) exchange rate below 1.20. This translates into a virtual floor at a cost of 1.20 francs per one euro. Specifically, the Swiss central bank (Snb) stated, “The Snb will enforce this minimum rate with the utmost determination and is prepared to buy foreign currency in unlimited quantities.” Simply put, they are prepared to turn on the printing press and let them run as long as necessary to weaken the franc against the euro, and other major currencies.
At the time of the announcement, the Eur/Chf was trading near 1.10 but within a trading session had rallied above what the Snb pegged as the floor. This was the largest one-day decline in the value of the franc in history.
Traders should put more emphasis on the avoidance of being a victim of intervention than how to profit from it. One thing to keep in mind is that central banks don’t want to intervene in the markets; they would rather do it behind closed doors. However, when dramatic results are needed, they resort to market “violence.” In most cases, central banks advertise their intentions to intervene in advance. The hope is the threats to take action will deter market participants enough to eliminate the need to actually act. If that doesn’t work, they intervene and anybody in the wrong place at the wrong time will pay dearly. Accordingly, it is important to always take intervention threats made by central banks seriously and use them as a cue to move to the sidelines. If you don’t and your position is antagonistic to their cause, they’ll drive you there anyway, but it will be an unpleasant experience.
For those who can’t stand the idea of missing out on a telegraphed market move, understand that central banks sometimes take weeks to implement an intervention threat and, in the meantime, prices can move substantially. Accordingly, simply selling a futures contract and hoping to capitalize might not work. It is probably better to execute a strategy with more room for error such as option spreads, short options or scale trading with the e-micro FX futures traded at the Cme Group. For instance, markets in need of intervention are typically volatile and at extreme prices; therefore, it is probably a good candidate for countertrend option selling, or countertrend lottery ticket buying (cheap out-of-the-money options).