Banki centralne

Central banks control monetary policy, which they may use to influence exchange rates. Central banks will frequently make statements to encourage a desired exchange rate change or directly intervene in currency markets to buy or sell currency. It is important to pay attention to central banks, their statements as well as their actions.

Important central banks to pay attention to are:

• United States –The Federal Reserve Bank is the U.S. central bank. While the Department of the Treasury is responsible for printing money, the Federal Reserve Bank sets interest rates and is responsible for monetary policy. As 85% of all currency trading involves the U.S. Dollar, this is the central bank to watch.

• Eurozone –The European Central Bank (ECB) is the central bank for the Eurozone. The ECB sets monetary policy, interest rates and the money supply for the world’s largest economic trading zone. EUR USD is the most actively traded currency pair.

• Japan –The Bank of Japan (BOJ) is the central bank of Japan, but the Ministry of Finance (MOF) is the most powerful ministry in Japan and controls the currency. MOF has a long history of currency market intervention, primarily to weaken the Japanese Yen to help Japan’s export-led economy.

• Great Britain –The Bank of England (BOE) is the central bank, but the Chancellor of the Exchequer is responsible for the British pound. The BOE and Chancellor of the Exchequer have been largely removed from currency matters for some time.

• Switzerland –The Swiss National Bank (SNB) is the central bank and responsible for the Swiss franc (CHF). SNB has been actively trying to limit Swiss franc strength against the euro (EUR) and has set an exchange rate cap.

• Australia –The Reserve Bank of Australia (RBA) is the central bank of Australia and is responsible for the Australian dollar and monetary policy. Because of the importance of exports to the Australian economy, RBA actively uses interest rates and monetary policy to maintain competitive exchange rates.

Currency Market Intervention

Central banks have been known to intervene, alone or in coordination with other central banks, in the currency markets to affect exchange rates by buying or selling currencies. Generally, central banks will first try to make verbal pronouncements about desired exchange rate levels, hoping that they will cause exchange rates to move to desired levels, without having to resort to intervention. Most recent interventions have involved the SNB placing a cap on the EUR CHF rate and BOJ interventions to weaken the Japanese yen.

Central bank interventions to weaken their national currency tend to be more effective, because the central bank could potentially print endless amounts of a currency to weaken it. The most famous failure of a central bank intervention to support its currency was by the BOE in 1992. This was unsuccessful as there turned out to be an almost unlimited number of sellers of Great Britain pounds (GBP).

Financial Stability

The strength of a currency is now tightly linked to the perception of the financial stability of the country that stands behind it.

The Eurozone debt crisis of 2009-2010 is the most obvious example of this and it continues to this day. The U.S. dollar’s (USD) standing as the global reserve currency of choice may be called into question, if the U. S. does not begin to address many of its pressing fiscal issues.

Key factors in analyzing a country’s financial stability are:

• Debt to GDP Ratio –The percentage of total sovereign debt to a country’s gross domestic product (GDP) is a commonly used measure to assess financial stability. A debt / GDP ratio of over 85% is of concern.

• Deficit to GDP Ratio –Current and forecast budget deficits relative to gross domestic product (GDP) are another measure of financial stability. The higher the deficit as a percentage of GDP, the greater the concern. Deficit to GDP percentages approaching 5% - 7% are of concern.

• GDP Growth Rates –Low or negative GDP growth has implications to a country’s ability to service its debt. This is a concern in the Eurozone, where many countries have low to negative growth at a time when they are trying to reduce spending.

Credit Risk

Relative changes in a country’s creditworthiness influence exchange rates. The following are good indicators of creditworthiness. Changes in these indicators should be monitored and paid attention to:

• Credit Ratings –All of the major credit rating firms (Moody’s, Standard & Poor’s and Fitch) produce sovereign debt ratings. The potential downgrade of a country’s debt can produce a negative change in exchange rates.

• Yield Spreads –Changes in the interest rates paid in the capital markets for government debt can be an early indicator of increased or reduced concerns about a country’s ability to borrow and service its debt. The 10-year bond yield, for example, is a benchmark that is easily followed. A sudden increase in one country’s borrowing cost will usually produce a negative change in exchange rates.

• Credit Default Swaps (CDS) –Credit default swaps are traded like insurance policies on the performance of a debt instrument. The buyer pays a premium to the seller and the seller guarantees against a defaulted payment on the debt. Like a sudden increase in a benchmark debt yield, a sudden increase in CDS spreads can precede a negative change in exchange rates.

• Debt Auction Results –Another fundamental indicator to pay attention to is the announced results of government debt auctions. How much of the debt issuance was subscribed to and the rate paid is used to determine whether the auction was considered successful or not. An unsuccessful auction may produce a negative change in exchange rates.

Geopolitical Risks and Events

Because currencies reflect global trade, any events which potentially disrupt trade (such as crude oil moving through the Straits of Hormuz, or the Fukushima nuclear accident in Japan) can trigger sharp moves in exchange rates.

A real or perceived increase in risk can cause a flight-to-quality response where many riskier assets and currencies are sold and safe-haven assets and currencies are purchased. Currencies, such as the U.S. dollar (USD) and Swiss franc (CHF), are considered safe-haven currencies and will be the beneficiary of a flight to quality. U.S. dollars (USD) will be purchased as riskier, non-dollar denominated assets are sold and the proceeds are moved into U.S. dollars (USD) to purchase U.S. Treasury obligations.

Risk-on / Risk-off Trades

When global events turn positive, riskier assets are purchased (risk on). When global events turn negative, riskier assets are sold and less-risky assets purchased (risk off). Changes in sentiment frequently occur overnight with the latest economic data release or news development. So common are these changes in sentiment become that the resulting market impact is now simply referred to as the “risk-on, risk-off” trade.

The major beneficiary of risk-on trades are the commodity currencies (Australian dollar (AUD), Canadian dollar (CAD) and New Zealand dollar (NZD)), the euro (EUR) and Great Britain pound (GBP). For the risk-off trade, the U.S. dollar (USD), Japanese yen (JPY) and the Swiss franc (CHF) will be purchased.

Gauges of Risk Sentiment

A number of indicators of overall market risk sentiment may be monitored. These may be used to gauge increasing risk tolerance or risk aversion

• VIX Index –VIX is a measure of the volatility of the S&P 500 stock index. It is a common measure of market risk sentiment. The higher the VIX, the greater the market risk aversion.

• U.S. Government Bond Yields –Watch 10-year U.S. government bond interest yields. If they decline sharply it indicates increased risk aversion.

• Emerging Market Stock Markets –These are another good gauge of investor risk sentiment. If they trade sharply lower it indicates increased risk aversion.

Economic Indicators

Economic indicators are financial and economic data which may be used to assess the strength of the economy. Economic data and reports are regularly produced by governments and private firms and are widely followed. Because of their wide following, many of these indicators can have an enormous impact on the markets, especially when the report is not consistent with market expectations.

What do I need to know about economic data release?

You do not need to know the details about every economic news release, but rather what does it say about the economy and whether it is consistent with other data and the market perceptions.

Some economic data is relevant to growth and some is relevant to inflation. If economic growth is of greater concern than inflation, then economic reports focusing on growth will have a greater impact.

Questions to keep in mind are:

• What does it mean for economic growth, inflation or interest rates?

• Was it in line with consensus forecasts or a surprise?

• Does it support or contradict the general view of economic growth?

• How did the markets react?

Consensus Expectations

Remember the data may be less important than whether it is consistent with consensus expectations. Many economic news services, such as Bloomberg, conduct surveys of economists in advance of economic news releases and use the results to publish “consensus forecasts”. Data releases that are not consistent with the consensus forecast may trigger rapid liquidation and reversal of positions accumulated in anticipation of the consensus forecast being borne out.

This can create excellent trading opportunities, but it is usually prudent to wait several hours for the market to find a new level after surprise data is released. Also keep in mind that most economic data releases will include revisions to prior data. Sometimes the revisions to prior data are more important than the new data.