Financial textbooks tell us that markets move according to fundamental influences, whether they be of an economic, financial, political or crisis-related nature. But, experience often counters this basic axiom by suggesting that perception, not reality, is the true market driver. In a way, both statements are correct because perceptions are formed in an attempt to guess what the true reality might be.
Our current forex market, however, seems permanently attached to the perception model and guessing the mindset of two men, those vaunted chiefs of central banking, the inimitable Ben Bernanke and Mario Draghi. This “tag team” of sorts has spoiled even the best-laid plans of countless currency speculators, both retail and institutional, as well as beginners and veterans alike.
Central bankers, the world over, have always been in agreement on one key point – they abhor all investors that focus on currency speculation as an art form and career. They long for the return of the Bretton-Woods agreement, where central banks set the exchange rates each day within a fixed bandwidth. The revolution in the seventies that created floating currency markets never received their support, but, like it or not, the forex market is here to stay, and, by the way, it is our largest and most liquid market.
Speculators claim that their activities have provided this volume and liquidity, a good thing, when it comes to determining fair exchange rates in today’s global financial markets. But Bernanke and Draghi do not agree. For some reason, they feel their enormous insights should dictate the movements in the market, as can be seen in the following “EUR/USD” chart:
The “EUR/USD” currency pair is the most heavily traded combination in the market, yet recently, due to the lack of extremely positive economic progress in either the States or in Europe, traders have floundered over the past year in their search for an appropriate valuation of the pair. It is difficult to make money in ranging markets. If the fundamentals are not present, then rumors and outright guesses can generate trends, too.
The first half of the chart could be described as “normal”. A new QE3 program by the Fed led to a weakening of the Dollar, but dealing successfully with the “financial cliff” produced the strong reversal in the other direction. After those predictable actions ran their course, Bernanke and Draghi jumped into the fray to manipulate the forex markets, assuming ostensibly that stability in cross-border rates would subdue inflation in both regions. But, inflation is not the core problem. The lack of dramatic GDP growth is the real problem that needs fixing, and it continues to confound officials on both continents.
In the absence of intervention by these two principals, most analysts, it is safe to say, would claim that the Euro would drop out of the sky like the Hindenburg, but central bankers are not high on “crash-and-burn” scenarios. The strength of the Euro, however, constitutes the last vestige of austerity measures that have not produced results. Draghi, in response to his critics, hinted that a weaker Euro may be in the cards and that a negative savings rate for banks might do the trick. The Euro fell, but Mario changed his mind in a week, and then the Euro bounced back.
As if on cue, Bernanke followed Draghi’s lead and hinted that tapering might begin earlier than expected in 2013. The Dollar strengthened, and the Euro plummeted, but he also recanted, causing an immediate reversal.
What’s next? The “triangle” in the chart is tightening its grip. The Euro may head a little north in the near term, but expect a fall from grace, sooner, rather than later.
Read more about central bank intervention here.