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Systems are fully loaded on the "risk off" side of the trade



The systematic trend following models are all fully loaded up now for the deflationary risk off trade.  The Detma output above shows that it is almost 100% long USD (except versus the NZD) and 100% long JPY versus AUD, GBP and EUR.  D6 will turn long the JPY versus the USD if it closes below 92.73 at N.Y. close tonight.

Systematic models, by their very nature, need to follow the signals generated by their various algorithms.  In the main, the only input into this automated decision making process is the market price action.  This is a good and bad thing.  It's a good thing because these models will identify a trend and stay on it until it expires and they will also identify this trend usually well before most other traders.  The price they pay for this however is that they need to be invested all the time and as a consequence tend to get churned substantially when the market is chopping around.

In 2008 systematic CTA models demonstrated their extreme value by being the only profitable asset class and returning upwards of 30% for the year when all else was down similar to much greater amounts (I'm not including cash as an asset class here).

From around march 2009 it has been a different story for systematic programs since they have been mercilessly churned by the risk on/ risk off price action that has occurred.  The big question now is since these models, as demonstrated by the Detma model, are loaded up on the risk off trade, are they going to get burnt again or are they ahead of the market as they can be.

The Australian dollar has been a good proxy for the risk on trade (or the carry trade) since March 2009.  Over the period from then to today it has risen from around .6000 to .9400.  There are many reasons to support the AUDUSD but it suffers quickly when the market is in the risk off mode.  We saw evidence of this last Thursday as it was sold down from .9320 to .8700 in four days.

Since November 2009 the AUDUSD has been in a very broad .9400 to .8600 range.  This range reflects the market's uncertainty in trying to determine whether it is all going to hold together or fall apart.  At the extremes of this range is where you will find the systematic models, all loaded up and ready to go, but unfortunately they have been dragged back each time and sent the other way.  So that is where we are again today. At the extreme lows of the EURUSD.  Is there more in it and will we see another episode like 2008?

My "A simple message" post earlier today was tongue in cheek to a great extent but the overriding idea I have wanted to get across over the last couple of days is that if central banks don't take decisive action, it is all going to fall apart.  The world financial system has not recovered from the GFC, it still needs years to do that.  But if central banks don't step in and provide the stage for the global recovery that is required, then things are going to get nasty and 2008 will look like a mild blip in comparison.

So on that basis I'm assuming that things will hold together - until they don't.  With that in mind, the EURUSD chart shows that we may have indeed made a low in the EURO.  Whether it is heavily supported by central banks or not we may never know.  But if it holds these lows I think the world will take a breather and at the very least we will see a bounce in the EURUSD to 1.4000 if not a lot higher.

Position wise, I was happy to wake up and see it down at 1.2620 again.  That provided a good entry point based on my current thinking.  So I'm long EURUSD and will cut if 1.2550 breaks.

Frank



Disclosure: Long EURUSD