If a hedge fund tried to game a central bank today, as George Soros' Quantum Fund did to the Bank of England in 1992, the likely scenario might be Central bankers getting together to determine the size of the funds position, then calculating how much of a currency move was needed to wipe out two-thirds of that fund, and moving the currency accordingly until a climactic move incinerated the speculators and allowed the central bankers to exit their own positions. If you think this scenario is an exacerbation, or feel ECB honcho Mario Draghi got lucky when his warning earlier in the summer that "it is pointless to short the Euro", proved prophetic, you may want to think again.
While there is nothing new historically about the biggest player in a market getting their way, it still seems novel that central bankers would be playing the role of that biggest player. Or is it? One of the most memorable examples of market manipulation on a grand scale by a government was when Bill Clinton, his Treasury Secretary Larry Rubin, and then Fed Chairman Alan Greenspan targeted lower long-term interest rates, i.e.: long bonds, to improve the economy. Previously the Fed generally only attempted to influence the short end of the yield curve. To the surprise of Wall Street, and bank and prop traders, aka: the Bond Vigilantes, the grand plan worked, and the Fed has relied on muscling interest rates lower when it needs to try to jump-start the economy ever since. What made that watershed event so significant to all of us was, it marked the beginning of a shift in the marketplace from a mean reverting environment where securities and currencies moved in wide bands as they oscillated around a rough mean determined by interest-rates and growth, to a fractal based marketplace where Keynesian policies trump current economic conditions and price movement is influenced more by existing price patterns than day to day news. Which brings us back to Draghi and the Euro: once the climactic price move to drive out short speculators has been executed, the market, true to its chaotic nature, will most likely downshift as it creates a new, less volatile pattern. Please remember that the term "chaos" in science refers to something that appears on the surface to be random yet is guided by an overriding orderly structure. Our educated guess is that the new pattern which develops in the Euro once the current short covering rally has run its course will likely be in-line with the existing long-term patterns, which are still bearish - see Figure 1.
What stands out for us on the Daily Euro chart in Figure 1 is how this most recent price rally is relatively small from a historic standpoint and certainly in-line with the current primary pattern. In fact this current rally which kicked off in mid-summer is still smaller than the previous bull corrections in the early fall of 2011 and the late winter of 2012. Yet from the standpoint of Euro shorts it is significant because no matter how good your timing was, if you have shorted the currency anywhere since mid-May you are currently under water. Likewise from the perspective of analysts and traders who earn their daily bread by predicting appropriate market positions by interpreting fundamental information, aside from price action, and who find the Euro currently in the upper half of its 2012 range, despite all the bad news in Euro-land, this modest move is nothing short of lethal, even close to catastrophic. On the other hand the recent rally is a positive for European money centers, and thus European citizens, because it helps that the money that is being paid back is not being overly devalued.
As for that overriding orderly structure known as chaos which maps the apparent randomness, the chart in Figure 1 looks to us to epitomize that.
Jay Norris is the author of The Secret to Trading Forex, Futures, and ETF's: Risk Tolerance Threshold Theory
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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.