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Forex Volatility Attracting New Players

It appears that we have an agitated, unhappy world, which has created tension and political uncertainty in North Africa, and the Mid-East.  This, combined with a glut of economic data which has all served to attract speculator attention.  At the CME yesterday, there was an increase of over 31,000 contracts of foreign exchange futures and 5,300 of options.  With 1,133k of futures contracts, and 603k of options this is not a large percentage increase, but the open interest did go up in all of the major currencies, an unusual occurrence.

We know from the latest COT report that the specs are long all other currencies and short the USD, with the exception of the yen.  The total net short USD position in the comprehensive combined futures and option position was 265,722 in last week's report.  This means that specs were adding to their long positions yesterday.  Had they been liquidating, the OI would have gone down.

So the spec consensus is to sell the USD.  They have the position on in the futures, and as long as the money flows into the market, this is a self fulfilling trade.  One of the major drivers seems to be an attitude that the recovery is, according to recent data, taking hold, and the Europeans are going to be quicker to raise the rates than the Fed.  The euro bankers see energy and food inflation and fear it will spread, while in the US, food and energy inflation only matters on Main Street.  In Washington, the core inflation rate matters to the policy makers.

There may be some fallacies in the analysis.   The hearty economic numbers in Europe, and the US, are the result of what conditions were, not what they are today.  Higher energy prices in most of the US, where there is no public transportation, is a sadistic tax affecting most of the country.  Yes it might be considered inflationary as oil prices have gone up, but for most of America the extra money spent on energy, means less money will be spent on something else.  With a surfeit of housing, commercial real estate, retailing outlets, manufacturing capability, construction capacity, and labor, not to mention bankers, how is the run up in oil prices going to cause sustained inflation.  More likely the seeds for a recession, and deflation are being sowed.

The metronome which keeps time for the laws of supply and demand moves very slowly indeed, and is perhaps one of the reasons economics is so poorly understood.  Change the price of a product, and the supply demand will be altered..sometime.  How soon will there be, for example, a massive conversion of natural gas as energy for cars and trucks in the US with the current energy price differential?  What about the economic changes caused by the Frank/Dodd Financial Reform Act?  Current economic activity may be the result of a forgotten change that happened months or years ago.

One of the winners over the past several weeks has been the Swiss Franc.  The USD/CHF traded at .9770 going back the last 15 days.  Then the USD plunged to a multi year low, trading under .93.   The weekly sell off started back in early December at around 100.  On the weekly, we are again flirting with the bottom of the Bollinger Band, and on a couple of previous occasions we have had 3/400 point relief rallies from this area.  While there is no end in sight to the Mid-East turmoil, the oil sheiks have had ample time to convert their extra billions of mad money to the safe haven SF, or perhaps the British pound.  Was this part of the recent SF appreciation? 

As a contrarian trade let's take a look at trying the long side of the USD/CHF under .93.  It is hard to say what might give us a rally, but when there are so many lined up on one side of the market, it might not take much.  Best not to risk too many pips on this trade however.