FX CONCEPTS FX CONCEPTS

GLOBAL MACRO RESEARCH GLOBAL MACRO RESEARCH

CURRENCIES INTEREST RATES EQUITIES COMMODITIES
To contact FX CONCEPTS New York: 1 (212) 554-6830; London: +44 20 7213 9600; Singapore: (65) 67352898; research@fx-concepts.com


MARKET INSIGHT REPORT
Will the Last One Out Please Turn Off the Lights
By John R Taylor, Jr.
Chief Investment Officer
It is not just the demise of FX Concepts that has made our personal view of the world
bleak during this past year, but also the deepening predicament of the entire foreign
exchange business, from interbank trading to currency management to political
blundering to a lack of macro reality perception. This is a widely underappreciated
danger for global trade, cross-border investment, future growth, and global bank
survival. Technology has brought some of these woes upon us, as our information
advantage over the customer has grown so dramatically to allow risk free trading for the
Goldmans and JP Morgans of the world. Put that together with everyones desire to
outwit and take pennies away from the nebulous other side and we have been undone.
High frequency trading and the banks part in the fixing or better said, the gaming, of
the WM rates mixed with (very understandable) regulatory navet and lurid publicity
have crippled the FX market. This is only one financial crisis away from bringing the
whole banking system to its knees (think bail-in). We could write hundreds of pages
about these inter-related issues and I look forward to discussing the technical,
psychological, historical and moral dimensions of them (and what has been written so
far) over coffee, wine, or harder stuff, with anyone interested, but not here. What we
want to do in this short letter is to put forward our understanding of what the hobbling of
this largest global market will do to volatility, price discovery, liquidity and how those
changes will impact economic surprises sure to come in the years ahead.

Two images come immediately to my wandering mind when thinking about the future of
trading rooms in the coming years and maybe were there already. The first is the last
two weeks of August when historically everyone is on vacation and the fourth-string is
watching the desk. I remember someone doing a lira trade against the dollar, thinking
the lira amount was dollars and causing a move of over 1% in a short time, while also
destroying all the intra-European crosses along the way. Today, the machine would
certainly shut itself off, but who would do the business it might be real and those
trades must be done. What happens to the price? Is there really any liquidity when the
ones and twos are all hit and all the systems back away, but the volume to clear the
market is really hundreds of thousands of ones and twos? Do the central banks bail us
out you must be dreaming! This would look like a flash crash, a multiple of the August
lira trade above, but this is not a mistake, no immediate reversal is ahead. It is a change
in price that has blown away the liquidity that was no longer there. No people with risk
authority and no risk capital in the system is the new reality. When business is done in
ones and twos in a two-way market, things are great, but why should a bank risk its
capital? The reward is gone and if there is some, it is probably illegal

The second image is of the 1970s. Low to no liquidity and cold nose was the order of
the day. Markets ran all over the place, banks did not commit the capital, and central
banks had absolutely no control. Global trade was the dominant factor in the market and
corporations were at great risk because movements were so large relative to profit
margins. Cross border investing was almost non-existent partly because it was so risky
in a currency and liquidity sense. Global investment grew with FX, will it shrink with it
too? Trend following was king because there was no liquidity to stand up to the most
recent move. Options could make the future different because back then there was few
options, but lack of capital and liquidity will shrink options portfolios too.

FX CONCEPTS FX CONCEPTS
GLOBAL MACRO RESEARCH GLOBAL MACRO RESEARCH
CURRENCIES INTEREST RATES EQUITIES COMMODITIES
To contact FX CONCEPTS New York: 1 (212) 554-6830; London: +44 20 7213 9600; Singapore: (65) 67352898; research@fx-concepts.com


CURRENCY Europe Long-Term View

Has the Dollar Turned Up Against the Swiss?
By John R. Taylor, Jr.


The Swiss franc has often acted as the canary in the
coal mine for the entire currency world versus the US
dollar and there is a chance it is playing that role
again. Last May the dollar reached its high against
the Swiss franc about seven weeks before it reached
its high against the euro. This year, the dollar seems
as if it has made its low against the Swiss franc on
March 13, just a hair below the .8700 level, but it is
not clear the EUR/USD or several other European
currencies have finished their uptrend. The last
possible spot for these highs should be at the start of
the week of May 5, just about seven weeks after the USD/CHF low. Of course, much of
the expected risk-on mood depends on the economic and confidence news that is
clustered around the end of the month. We have already started with Wednesdays
Chinese and European PMI projections. The Chinese PMI was not as good as hoped.
Although the European ones looked good, too much of the positive was a function of the
German input, something that is heavily discounted as we all know those numbers are
not the ones we are worried about. The critical numbers will come next week with the
FOMC on Wednesday, where the tapering will be continued but the world will be reading
the nuances in Janet Yellens words and waiting to see what the other governors might
say as well. This is followed by the real PMI readings and US non-farm payrolls. As all
of this news is coming out at the end of what we believe is an important last gasp
attempt to continue a very tired uptrend, a bad number or some negative words could
cause the turn.

The technical picture for the USD/CHF shows we are very close to breaking above the
downtrend from the July 2013 EUR/USD high. It is right around the .8870 level as of the
time of this writing. As the USD/CHF touched a high of .8855 on Wednesday, we are not
far away. However, the cycles argue we should have at least five trading days of dollar
weakness ahead, taking us into the FOMC meeting. If this weakness proves
inconsequential or is reversed by fundamental factors and the dollar closes above .8870,
we will argue that a new and significant dollar uptrend has begun. Our target for the
expected cyclical peak in June is around the .9000 level.

Our cycles for the equity market also call for a peak around the start of May, but we do
not necessarily expect that to coincide with a weakening of the economy. A stronger
economy implies higher interest rates, higher commodity prices, including oil and food,
and higher inflation. All of these things are negatively correlated to the equity market at
this point in the very major cycles. A decline in the euro and all the currencies
related to it and a weakening equity market do not depend on things going wrong.
This reversal is more the ordinary course of events than something extraordinary. A
further crisis in the Ukraine or a more aggressive weakening in Chinese growth could
upset this quiet apple cart, but we do not expect the fruit will fall.