Expect the Unexpected in Global Financial Markets and Do Something about It
February 6, 2014
It’s still early times for 2014, but a pattern of unexpected developments has already surfaced. Lower long-term interest rates, weaker share prices, a firmer yen, a resilient euro, and a string of central bank rate hikes despite subdued global growth and inflation authorized instead to stop falling emerging market currencies were surprising. The configuration of stable oil, firmer gold, but depreciating commodity-sensitive currencies like the loonie, Aussie dollar and kiwi also looks puzzling. At first glance, the severe winter in much of the United States seems bizarre in this age of global warming, the point being that the new normal encompasses greater growth-dampening weather extremes of all kinds. It’s strange, too, that a U.S. president losing voter approval yet with three years left to govern would have produced a State of the Union address totally lacking in boldness and on the whole really boring.
A policy buzzword since the onset of the subprime mortgage market meltdown has been uncertainty, and it’s still thrown out often to the public as an excuse by policymakers. But how does one contrive decision-making strategies when confronted time and again by missing key facts? Since my earliest days as a market watcher in the mid-1970s, I’ve been struck by how often the market consensus gets future currency movement plainly wrong, and it isn’t just recently that I’ve felt one can do a lot worse than trading consistently against the crowd. There are differences now than then, moreover, that make such a plan appear even sounder and certainly easier to put into practice than it was ten or 30 years ago. The currency arena used to be a game limited to professionals, with no personal computers for trading or analysis, and where highly skilled interbank gunslingers routinely quoted prices to buy as well as sell without knowing which side of the market they would be asked to trade. It was very hard to see the big picture that now can be gleaned from the myriad currency forums available on the internet.
The market consensus for any number of events — a data release, a planned news conference, a political event, you name it — is readily obtainable now. In 1989, when such information existed for U.S. economic statistics, a parallel system covering the released economic data of other countries was in its infancy. I know because I was asked by the investment advisory firm for which I worked to develop a data calendar with in-house estimates that I was to produce and consensus forecasts to be drawn from a survey of other analysts predicting the usual suspects of foreign data. To my surprise, I discovered that extremely few outfits in New York were doing that kind of thing and ended up relying heavily on European sources to formulate a consensus. Yet another hurdle was the concealment of data release times. German officials rarely gave that information to the public.
The age of ever-present cyber-connection has stripped away the immense barriers to entry in currency trading that used to exist. This change in the landscape of the game has augmented the herd properties of decision-making in the trades people are predisposed to make.
The importance of this digression into the evolution of “consensus” estimates is that the very concept of a consensus has become much more transparent and obtainable, and this development has increased the propensity for currency positions to become way oversold or way overbought. In such circumstances, currency trends get deprived of the oxygen needed to extend direction, and a path of least resistance opposite to what is presumed to be consensus opens up. Put differently, market positioning trumps the so-called “economic fundamentals” time and again. But here’s the rub. Gleaning a complete sense of how the market is position is much harder to do than learning what people are expecting from a coming event that might influence psychology toward currencies..
One needs therefore to devise a consistent strategy that acknowledges that economic fundamentals are important long-term market price determinants but not very useful in the immediate term ahead. It would be great to learn the inside story about the cards everyone is holding, but market positioning is not quantifiable in many instances. A third way is offered by contrarian trading. Learn what people say is most likely to happen, and trade against that tide in most instances. At its core, such a strategy is faith-based, and that can deter many folks.
Copyright 2014, Larry Greenberg. All rights reserved. No secondary distribution without express permission.
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