One Reader Asked A Question. Here's The Answer


A couple of weeks ago, one reader asked why I persisted in speaking a foreign language.

I want to answer that question with the help of some excerpts from a former derivatives trader.

Don't worry, there are charts too.

Note to self: self-righteous article titles are a recipe for disaster.

A couple of weeks ago, I got the not-so-bright idea to post something called "I'm Tired Of Regular Investors Getting Hung Out To Dry (Thoughts On A Monday)."

Turns out, some people would have preferred I kept those Monday "thoughts" to myself.

But although the title was, in retrospect, not a great idea, the post itself was well-intentioned.

The point was to kind of reinforce the notion that US equity markets (NYSEARCA:SPY) are being driven almost tick-for-tick by FX (specifically, USDJPY) and rates (Treasury yields). And further, that retail investors are fed a steady stream of largely meaningless macro content masquerading as "analysis" as opposed to content that explains how the market really works.

That's true. And all I was really asking anyone to do was pull up a chart of USDJPY (NYSEARCA:FXY) and 10Y yields (NYSEARCA:TLT), plot them against S&P futs and keep an eye on it throughout the day to get an idea of what the pros watch and in turn, what the pros trade on. One commenter had the following question for Heisenberg:

...why not stop talking the FX foreign language of interest rates to which you are overwhelmingly committed, and tell people specifically what to buy, what to sell, and when to do it?

So, a couple of things there. First, I was trying to do exactly that, which is what makes that comment so amusing. Second, if you asked the "why not stop talking about FX and rates" bit on a trading floor, you'd get the following question back: "are you feeling ok today?"

When I used to trade, my colleagues and I had a running joke every time stocks would inexplicably ramp during the middle of the day when it looked like things were starting to fall apart. We'd say the following:

This is all USDJPY!

The thing about that joke is that it wasn't really a joke. It was the truth. Let me share with you a meme created earlier this week by Kevin Muir, a former derivatives trader on Bay Street:

Not to put too fine a point on it, but that's basically Kevin having a little fun at the expense of people who don't understand how this works (although he seems to be a more polite guy than me, so he probably wouldn't put it that way).

The post that's from is called "We're All Yen Traders Now," and it's a fantastic read. Have a look at this chart from that piece:

(BBG, Kevin Muir)

See what we're trying to tell you? That's not a coincidence. And neither is this:

(BBG, Kevin Muir)

So to answer the above cited reader's question (i.e. "why not stop talking the FX foreign language of interest rates?"), well, that's why.

And to answer the other part of the same question (i.e. "why not tell people specifically what to buy, what to sell, and when to do it?") well, first, I don't do that and neither should anyone else without knowing readers' specific circumstances, but more to the point, that commenter seemed to completely miss what I was trying to say. Namely, that if you watch USDJPY and Treasury yields, you'll know what's coming up for equities.

Need a more granular look than those two charts? Fine. Here's the last two days:

Does that look like a coincidence to you? No? That's because it's not. And that's why I've been so keen on talking about the relationship between equities, FX, and rates.

There are good sources of information out there. Kevin's blog (linked above) is a good example of a place where you can find free analysis from a professional trader presented in a way that's designed to be both funny and accessible. He's actually better than I am at it.

But you have to learn to separate the wheat from the chaff. Not everyone's a Kevin or a Heisenberg. Too much of what retail investors are exposed to is just fluff or worse, it's fluff pretending to be professional-level macro research. That's what I was trying to convey weeks ago in the post mentioned here at the outset.

A great way to end this particular piece is by reminding you of another point I've been pounding the table on that far too many commenters here contest at the expense of other readers. Namely that this is all a function of central bank largesse. How does that relate to the above, you ask? Great question. And I'll leave it to the above-mentioned Kevin Muir to give you the answer:

The Japanese exchange rate is being influenced by massive distortions with their unprecedented quantitative easing programs. And that's the rub. The Yen is not 'tracking' but instead 'creating' these moves in the U.S. capital markets. We might kid ourselves that U.S. financial markets are reacting to fundamental news, but all too often, they are simply moving to the price on the Bank of Japan's last blue ticket.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.