Profit from volatility with forex
While markets hate uncertainty, it can also present opportunities. And the extra volatility it has created in the foreign-exchange market recently has created a wealth of possibilities for the short-term trader, says professional investor Jane Foley. Here, she explains how to profit.
Each week, a professional investor tells MoneyWeek where she'd put her money now. This week:Jane Foley, research director at Forex.com.
The markets hate uncertainty. It can send investors in risky assets flocking for the doors; within the stockmarket it is associated with a bearish trend. But uncertainty can also create opportunity. Indeed, the extra volatility it has created in the foreign-exchange market has created a wealth of possibilities for the short-term forex trader.
As Greece's fiscal crisis spread beyond its boundaries, through the eurozone and beyond, speculators used short positions to bet against the euro. As contagion spread, EU officials were eventually forced to take the bull by the horns. An EU and International Monetary Fund (IMF) bailout fund of €750bn has been agreed. The massive package swept aside fears that the Greek government would default on its debt obligations in the foreseeable future and triggered a huge (though short-lived) relief rally in global markets.
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However, the plan fails to provide any guarantees that Greece will start living within its means. It is still possible that Greece will have to default on its debt obligations and potentially be released from the European monetary union altogether. And despite attempts by the EU to calm the crisis, event risk in the eurozone is still very much alive. As a consequence, the euro could retain a negative bias for some time yet.
Meanwhile, American economic fundamentals are currently far from perfect. However, the eurozone crisis is good news for US dollar assets. The American budget deficit could be above 11% of GDP this year not far behind Greece's (13.6%). An aggressive American fiscal repair job is highly likely to start next year and this will hinder growth. The fact that America operates as a federal system and not as a cluster of sovereign states means that policy responses are clearer cut.
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For the time being, the crisis in the eurozone is likely to end speculation that global central banks will diversify away from US dollars in favour of the euro.
The world's second-biggest economy, Japan, suffers from huge debts, an ageing population and a declining savings ratio. So there's a huge fiscal problem looming for the next generation. That means the yen is no real contender either for reserve currency status.
This all suggests that a period of broad-based US dollar strength could be approaching. So any further squeezes higher in the EUR/USD rate may prove good USD buying opportunities. EUR/USD could be headed towards its long-term average of 1.18 and potentially lower.
In recent weeks investors have been reluctant to extend bets against sterling. It seems investors have been giving the British government the benefit of the doubt with respect to dealing with the enormous 11.5% of GDP budget deficit.
However, going forward sterling could be a harsh policy critic if the Liberal-Conservative coalition fails to deliver on budget reform. But the initial signs are good. Further progress could see EUR/GBP pushing back towards 0.800 on a three-month view.
Finally, this month the Australian government announced that its budget should be back in surplus by 2012/2013. The Australian economy has benefited from its proximity to China and there is already a lot of good news priced into the dollar. That said, the poor outlook for the euro suggests there is potential for further gains to be squeezed out of AUD/EUR.
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