The year 2006 is turning out to be a year of extremes in weather, geopolitics and forex markets. The challenge for the forex trader is to filter out the noise of a current day’s events and seize opportunities for trading. Four currency pairs, the GBP/JPY, EUR/CHF, NZD/USD and NZD/JPY are at historical multiyear extremes. A closer look at some of them is worthwhile for gaining a better understanding of the dynamics of forex trading.
The geometry of the GBP/JPY price position has been truly amazing. This pair is within 250 pips of the key resistance level of 2.4800 set in 1998. But a multiple time analysis shows unsustainable momentum at these levels. The weekly patterns have been approaching a parabolic path (see “End of a high?”). This is a classic portender of a reversal. If conditions emerge that will reduce carry-trade advantages, a strong and quick reversal is possible.
Any economic data release showing a weakening growth rate in Britain or a sustainable one in Japan can be the impetus to a significant retracement in the GBP/JPY.
The yearly patterns of the EUR/CHF indicate another crosspair at an extreme. We can see this pair is at a key 32.8% Fibonacci level from the 1.8234 high of January 1993 (see “Reaching higher”). From a technical point of view this alone provides us with a solid alert for a reversal to the 1.4443 low of January 2002. The trend up from the lows is narrowing along with the compression in the pattern. The fundamentals also point to a move up as the Swiss economy compares well against the Euro zone.
Another extreme currency pair is the NZD/JPY. This pair recently reached a nearly 30-year resistance level and offers the highest interest rate differential in the market; NZD rates are at 7.25% and the JPY is at 0.25%.
While technical factors indicate extreme levels, there are also important fundamental forces affecting all these currency pairs. The GBP/JPY has gained from a superior British economy and an uncertain Japanese recovery. The interest rate differential between these countries has been driving money flow into Britain. But any improvement in Japan can trigger a massive selloff here if the carry trade environment shifts. Any slowdown in British recovery can spark a major selloff of this pair. The EUR/CHF is at a key resistance reflecting superior economic growth in Switzerland.
The New Zealand dollar is gaining strength with its very high interest rates at 7.25%. New Zealand’s rates, compared with Australia’s 6% and the United States’ 5.25%, have
had the ability to increase the demand for NZD and for its Uridashu bonds. The yield on the New Zealand three-year bonds is 1.76% higher than the equivalent U.S. notes.
The rise of the NZD/JPY pair has been in sync with the yield differential. However, New Zealand’s central bank can’t raise rates without a major recession risk and they can’t cut rates due to inflation fears. Rates are already 3.5% annualized. A slowdown can cause a major decline.
While it is impossible to time a top exactly, from a technical perspective these crosspairs are overbought and have a downside potential of 500 pips or more. The challenge for the forex trader will be how to construct a tactical approach for entry, stop targets or option instruments with recognition of risks. The critical factor for trading these pairs will be a good understanding of the macro-economic forces that have generated these patterns. As summer turns to fall, the world also seems to be at a pivot point in fundamentals, where global growth and interest rate increases are nearing the end of what has been a season of extreme price moves.
Abe Cofnas is president of learn4x.com LLC and author of Understanding Forex: Trading to Win. E-mail: firstname.lastname@example.org.