Skip to main content

What is the Best Fundamental Strategy in FX trading ?

The Best Fundamental Strategy to use in Forex trading:

Today I want to talk about what I consider to be one of the best medium to long term fundamental strategies in the foreign exchange market which is "Central banks monetary policy divergence", this is a strategy that has been used decades ago by big institutional traders, and it's still effective right now!

First of all why Central banks are very important to FX traders? 

Well, simply because they're the only institutions who can control the money supply of their currencies, and they do that by raising or lowering interest rates or by using more unconventional tools like quantitative easing which means buying government bonds,

So what is a Monetary policy divergence :

As the name suggests, basically it's when you have a different stance from a certain Central bank to another one, the extreme and easy example would be if you have a Central bank who is in a hiking cycle meaning that's willing to raise interest rates in the future, and another one who's pessimistic about the outlook of the economy and willing to lower the interest rates, this is the extreme case scenario but unfortunately life is not always that easy right!! especially in this era where rates are near zero and Central banks are monetizing government debt,
But the one thing about Forex which is very important is that it's all relative, for instance after the coronavirus outbreak we saw all major CB lowering Interest rates to near zero, is that means that the strategy is dead, well NO NO NO!!!

Here's why? and let's take a case study between the Central bank of New Zealand and the Central bank of Australia!

So after the COVID 19 outbreak both Central banks has lowered the interest rates from 1% to 0.25%, but the Central bank of Australia did mention on their statement that 0.25% would be the lower bound, which means that they will not lower IR anymore from there, on the other hand, the Central bank of New Zealand has made it clear that they're going to lower interest below zero in the future, and you can see below that money markets are pricing 36% of chance that the RBNZ will go to negative IR by April 2021,

The other thing is that the RBNZ has launched 70B$ of quantitative easing and recently they're raised that to 100B in their last August meeting, on the contrast the RBA has adopted the yield curve control on the three years treasury yield, the main goal was to caped the yield at 0.25%, but what's interesting is they didn't have to buy that much to maintain that level, so here we can see that both central banks did lower the interest at the same time on the same level but their outlook was a lot different, And you can see in the chart below how the Aussie dollar has outperformed the New Zealand dollar in the past 5 months by more than 10%, and from March lows to September highs that's more than 1000 pips dear trader!

 

 

Some things to keep in mind trading this strategy:

First, you have to always track the major economic indicators for those respective countries like Unemployment, Inflation, and GDP, because if a certain economic data comes below or above the expectation that the Central bank has forecasted, that may change their view on the future of Interest rates or QE,
Second, predicting that a certain currency would outperform another one in three months or a year is not enough to just go and pull the trigger, you have to wait for a confirmation from the market, and by that I mean to use your technical analysis to find the right timing to take the trade and also a level to put your stop loss and targets, ideally for this kind of long term trades you would focus more on the daily and weekly chart for those continuation patterns like bull-bear flags, Triangles and Head and shoulders... etc
And Finally, you have to ask if there is some upcoming Geopolitical Risk like the elections, Brexit, or US-China tension, because at that time the market will no longer focus on the interest rates differential and capital flows but more on politics and external factors.

 

Article by Halim Haddad,

Labels:

Comments

Post a Comment

Popular posts from this blog

Why I Turned Bearish on GOLD!

 Real Yields may have bottomed: I have been bullish on Gold since May last year, primarily because of falling real yields (Nominal Rates - Inflation Expectation) which historically have an inverse correlation with the yellow metal, the large stimulus that was provided by the US government has driven Inflation expectation Up while the central bank keeping the short end of the curve at near zero, the result is a falling Real yield, as we can see in the chart below. But now with the expectation of a strong recovery in 2021, we're starting to see nominal rates (10-year Treasury bond yield) on the rise, and with Inflation expectation already above the Fed target of 2% there is very little room for upside there. The outcome of this is that Nominal rates will start to go higher faster than Inflation Expectation I,e Rising Real yields which is the enemy of Gold. This can seem controversial for some people because there is a popular belief that Gold can be a hedge against Inflation. While t...
Post a Comment
Read more

FX Macro Themes for November

 Macro Themes for FX Majors: EUR/USD: as many health experts expected the second wave of Covid 19 is here, France, Germany, and Belgium are in lockdowns, and more countries to join in the coming weeks, for me that means two things. First, the fourth quarter growth will come below the expectations, and one of the factors behind the surge in the Euro from May is the better handling of Covid 19 from European countries especially Germany relative to the US, but now it's quite the opposite, Europe is in a lockdown and I don't think the US will go into that path, because their health system is in better shape and well prepared, Second, more easing to come from the ECB in the next month, the market is expecting at least 500bn euro increase in the size of the PEPP program.  I expect the Euro to trade lower going into that meeting and year-end, but it will eventually go higher against a structurally bearish US Dollar (Lower real yields, Reflation trade), and vaccines optimism at the en...
Post a Comment
Read more

Five reasons why i'm bullish on the US Dollar in the short term!

  Five reasons why i'm bullish on the US Dollar in the short term: 1) The Fed has announced average inflation targeting at the Jackson Hole but did not provide any inflation-outcome-based forward guidance so now they're sitting on the sideline, 2) Trump is making a comeback in the national polls and we could see the greenback rally into the US election,    3) After the start of the reopenings the US data has been outperforming and beating expectations relative to the rest of the world,   4) Based on the CFTC reports the Euro longs are so stretched now and climbed to nearly a decade tops, 5) Technically last week the dollar index DXY broke out of the trend channel and did hold after the retest, In conclusion, i don't think the market is ready to liquidate all USD shorts yet and there are certainly reasons why this is not the case, but at least we're due for a pullback in the near term.    Article by Halim Haddad,  
Post a Comment
Read more