We’ve heard a lot of talk lately by players in the markets about a problem that could raise its ugly head in a real crisis. Jamie Dimon, CEO of JP Morgan Chase, and Larry Summers, former Treasury Secretary, have warned about markets running out of liquidity.  But what does that really mean?  How could it impact you, the currency investor?

We all know that the currency markets are the most liquid markets in the world. At least the mainstream currency markets are. Smaller currencies may experience more volatility due to liquidity issues but that’s not what I am talking about here. The people I’ve mentioned were talking about a lack of liquidity in the U.S. Treasury market, the most liquid bond market in the world.  So, what’s up?

Basically, liquidity means having the other side of the trade available when you want to buy or sell something, and having it at a reasonable price. What has happened in the treasury market is a direct result of stepped up regulatory action in the U.S. bond market.  Whether or not you agree with the actions of the Obama administration under the Dodd-Frank law, one thing is for sure.  There are less big banks with active bond trading desks in the market.  And, there are less bond market dealers and traders in the market in general.  This means, there are less people to contact to find the other side of the trade at a reasonable price.

Former Treasury Secretary Lawrence Summers and the CEO of JP Morgan Chase, Jamie Dimon, have been very vocal recently about reduced liquidity in the bond market.

“I thought regulatory authorities made a mistake when they looked at each institution, and said, ‘You’ll be safer if you withdraw from the markets a bit,’ and then forget that if all institutions withdraw from the markets a bit, the markets would be less liquid. The markets themselves would be less safe. That would, in the end, hurt all institutions,” Summers said. 

“I think there is a real issue there. Frankly, a lot of the effort that’s going into macro prudential should be into making sure we have liquidity,” Summers said.

How does this affect a currency investor?  Two words—interest rates.  For instance, if a trader is looking to sell a bond and puts the offer into the market, he finds a buyer.  However, what if he can’t find a buyer at the price he is looking for?  Maybe the bond he is trying to sell doesn’t have as many trading desks willing to own a treasury at that price, so he has to lower his offer price.  Bond prices have an inverse relationship to interest rates.  So, if the price goes down, interest rates go up.

Now, what if we have a crisis in the ability of the U.S. government to pay back the money it has borrowed and therefore markets start demanding Uncle Sam pay them a higher interest rate for loaning them money. That means the prices of bonds go down.  Now lets assume that a whole bunch of people want to sell their lower yielding bonds.  But, there are not as many market makers so the price of a bond can get skewed up or down very quickly if most of the selling is one way.

That is what these people are talking about when they mention a liquidity crisis.

Again, how does that affect a currency investor.  Well, interest rates affect currency prices.  If rates in the U.S. go high quickly, which is what these people are talking about, then the level of of the dollar in the markets against other currencies would be affected.  Higher interest rates would cause higher demand for the dollar.  Of course if the underlying fundamentals of the dollar are questioned as well, this could negate this upward pressure.

However, as a currency investor, understanding what could happen in the markets is critical to making sound investment decision.

L.Todd Wood is a former emerging market debt trader with 18 years of Wall Street and international experience. He is also an author of historical fiction thriller novels. His first of several books, Currency, deals with the consequences of overwhelming sovereign debt.  He is a contributor to Fox Business,  Newsmax TV, and others.  LToddWood.com

….consolidates in subdued trading  

USDCAD Overnight Range 1.2175-1.2235      

USDCAD drifted higher in early New York trading although the move lacked urgency or conviction and it stalled just ahead of the downtrend line at 1.2240. US Jobless Claims were a tad higher than forecast but the underlying trend is supportive.

The Asian session was quiet. The release of the FOMC minutes yesterday afternoon failed to provide any inspiration to traders and the US dollar gave back prior gains. Even weaker than expected China Manufacturing PMI (Actual 49.1 vs. Forecast 49.3) didn’t spark much trading activity.The Bank of Japan is rumoured to be upgrading its assessment of the economy on Friday but since no change in monetary policy is expected, the currency should be unaffected.

Sterling was the story in Europe. A strong Retail Sales report (Actual 4.7% vs Forecast 3.8, y/y) squeezed GBPUSD shorts and the pair jumped from 1.5530 to 1.5675.

Friday morning brings Canadian Retail Sales and CPI data, both of which are expected to be soft which sets the bar low for an upward surprise.

USDCAD technical outlook

The USDCAD downtrend from the end of March remains intact while trading below 1.2240 with a break of 1.2160 pointing to further losses to 1.2080. A break above the 1.2240-60 area would lead to a test of the 1.2340-60 area. For today, USDCAD support is at 1.2190, 1.2160 and 1.2120.  Resistance is at 1.2220-, 1.2240 and 1.2270.

Today’s Range 1.2170-1.2240

Chart: USDCAD 4 hour with downtrend highlighted

Larger Chart

USDCAD Overnight Range 1.2200-1.2254    

USDCAD held on to yesterday’s gains despite being largely ignored in a lively overnight session. Across the board US dollar demand was the main theme. USDJPY ignored greatly improved Q1 prelim GDP and tested resistance at 121.05. AUDUSD ignored a stellar Consumer Confidence report and headed lower. In Europe, EURUSD selling drove EURUSD below 1.1100 to 1.1065 on the back of renewed EU/USA economic and interest rate divergences concerns. The BoE minutes were thought to be slightly hawkish which gave GBPUSD a short lived boost.

Yesterday’s speech by the BoC governor was vintage Poloz. He stuck to his view that growth will rebound and the economy will reach full capacity by the end of 2016 while simultaneously stating how uncertain everything was. Traders tuned him out.

FX markets are likely to trade in fairly narrow ranges until this afternoon’s release of the FOMC minutes. Any indication that the minutes were far more hawkish that what the statement implied, will ignite another bout of US dollar buying.

USDCAD technical outlook

The intraday USDCAD technicals are bullish while trading above 1.2140 although the rally has stalled within a narrow 1.2240-1.2260 band. Failure to decisively take out the top side resistance coupled with the breach of the minor uptrend line from Monday (at 1.2230) warns of further weakness to 1.2170.  Meanwhile, the downtrend line from the end of March remains intact.

Today’s Range 1.2190-1.2260

Chart: USDCAD 1 hour with resistance zone

Larger Chart

USDCAD Overnight Range (including Monday) 1.2008-1.2215      

USDCAD was in demand on Monday and the demand became a stampede by Tuesday, fueled by a broad based US dollar rally, stop-loss buying, and a strong US housing report this morning. (Housing Starts, Actual 1,135K vs forecast of 1,015k)  The San Francisco Fed may have encouraged dollar bulls yesterday when they released a report suggesting that US economic growth may be substantially higher than reported. That report, combined with this morning’s news out of Europe that the ECB would front load QE purchases in May and June to compensate for lower volumes in the summer months drove EURUSD lower, from 1.1448 to 1.1130 so far today.

In Asia, AUDUSD dropped following the RBA minutes which provided scope for further rate cuts due to the slowdown in China and weak capital expenditures.  At the same time NZDUSD popped when the RBNZ tweaked inflation forecasts upwards. GBPUSD traded lower on the back of a weak EUR and poor inflation data.

The key risk to the Canadian dollar today stems from a speech by BoC Governor, Stephen Poloz, in Charlottetown.

USDCAD technical outlook

The intraday USDCAD technicals are bullish above 1.2150 looking for a break of resistance in the 1.2190-1.2220 area to extend gains to 1.2260 and then 1.2320. However, 1.2220 zone represents strong resistance which has thwarted attempts higher since April 23. If this level breaks, it argues that a short term bottom is in place at 1.1950 and would target 1.2360.  For today, USD support is at 1.2150, 1.2120 and 1.2070. Resistance is at 1.2190, 1.2220 and 1.2260.

Today’s Range 1.2160-1.2220

Chart: USDCAD 4 hour with uptrend and resistance noted

Larger Chart

USDCAD Overnight Range 1.1982-1.2060    

Oil prices are sliding in conjunction with a broad based US dollar rally which has driven USDCAD to probe resistance in the 1.2060 area. A decisive move above this level will put 1.2120 in play. WTI oil prices are down to $58.54/bbl down from $60.70 yesterday. The long weekend in Canada may be adding to USDCAD gains as positions get adjusted. Today’s Canadian Manufacturing Shipments data blasted above forecasts rising 2.9% (forecast 1.2%) and completely erased last month’s losses.  USDCAD traders didn’t care and continued to buy dollars.

Kiwi came under renewed pressure in Asia on negative news from dairy giant, Fonterra.  AUDUSD retreated in sympathy. USDJPY showed signs of life, breaking above near term resistance at 1.1935 on a report that the BoJ was pondering a Reserve Rate cut. Both EURUSD and GBPUSD traded lower in a fairly quiet European session.

The key focus for next week will be Wednesday’s release of the FOMC minutes.

USDCAD technical outlook

The intraday USDCAD technicals bullish while trading above 1.2005 looking for a break above the 1.2060 area to extend gains to 1.2120. A move below 1.2000 will lead to 1.1960 and then another test of 1.1930. Above 1.2160 would suggest that a short term bottom is in place and lead to 1.1980-1.2260 consolidation.

The medium term uptrend from last September continues to be intact above 1.1930.

Today’s Range 1.2020-1.2110

Chart: USDCAD 1 hour with break of resistance noted

Largerr Chart