The Central Bank’s Intervention

 

The central bank’s intervention is the most important fundamental change in the FX market both in the short-term or long-term. The intervention should be noted for short-term traders as it results in 150 to 250 pips of daily movements in just a few minutes.

For long-term traders, interventions can lead to significant changes in current trends. This is because the central bank conveys its current position (change in existing policies or adherence to existing policies) and intention to the market.

In general, intervention is an essential factor to observe as it can have a huge ripple effect on exchange rates in the FX market. Although the intervention occurs at an unexpected moment, the market already knows the need for intervention days or weeks before the intervention occurs.

 

 

FX Market Reflects Interventions Earlier

 

The direction of intervention is generally known to the market in advance because the central bank is already well aware of the excessive strength/weakness of its currency in the market. These interventions may provide traders with the opportunity to make a big profit, but some traders remain vigilant at this time.

We must note that the trend can quickly reverse by intervention because speculators can enter the market to prevent central bank intervention. Whether or not opposition forces in the market will block central bank intervention depends mainly on the number of interventions, past success rates, degree of intervention, the timing of intervention and economic conditions.

This intervention occurs more frequently in so-called developing countries such as Thailand, Malaysia, and Indonesia than in the G7 currency. The reason is that excessive appreciation of the currency’s value in these developing countries undermines its export competitiveness and hinders economic recovery. Market intervention in G7 countries does not occur frequently, but its effect is significant. Although interventions do not happen often, interventions are critical in fundamental trading because they result in rapid fluctuations in exchange rate movements.

 

 

 

What Traders Should Do!

 

 

1. Actively deal with interventions.

 

Use the central bank’s warnings as a signal. We may use a strategy to enter the market from a short-term low point by utilising government intervention’s invisible support lines.

 

2. Avoid dealing against intervention.

 

There are always people who act the opposite in society. However, trading against market intervention may be profitable but carry enormous risks.

With one central bank intervention, the exchange rate can quickly fluctuate by 100 to 200 pips or more. As a result, stop orders can be executed, which can lead to more significant movement.

 

3. Use stop orders when intervention acts as a risk factor.

 

Because of the nature of the market, where transactions occur 24 hours a day, interventions can occur at any time of the day. Stop orders must be made simultaneously with position entry. They are significant when there is a considerable risk factor for intervention.

 

What is a Risk Reversal?

 

Risk reversals are useful indicators based on fundamentals, which we can use and multiple indicators in trading. The most vulnerable part of FX trading is that there are no accurate indicators to identify trading volume data and market sentiment. The only material available for market participants is the COT(Commitment of Trade) report from the U.S. CFTC(Commodity Exchange Commission).

The risk reversal indicator is consists of call options and put options for the same currency. This means the volatility difference between the underlying spot exchange rate with the same sensitivity (meaning options with the same delta value) and the call/put option with maturity.

For example, if the call option with a delta value other than one-month maturity is 0.25 and the put option is 0.20, the risk-reversal is 0.25-0.20 = 0.05. This is because the demand for call options is more significant than that for put options. The inherent volatility of the call is greater than that of put options, which the market expects to see a rise in prices.

Theoretically, the call and option must have the same intrinsic volatility, but it does not match the real world. Inherent volatility refers to volatility calculated by substituting an option’s price in a pricing model, whereas historical volatility refers to volatility calculated from historical price data.

If the call is very advantageous in these figures (call volatility >  put volatility), it is shown that the market prefers the call option to the put option. Conversely, if the put option is very advantageous in this figure, the put option is chosen in the market (put volatility > call volatility). Thus, the risk-reversal figures suggest the market position (overbuying or overselling).

 

 

Take Advantage of Option Volatility

 

Many hedge funds prefer option volatility data because it helps them gain a more in-depth and more precise picture of the market. Inherent volatility is a measure of exchange rate change expected over a given period based on past exchange rate changes.

This is usually calculated from the annual standard deviation data for daily price changes. Futures prices help calculate inherent volatility and are also used to calculate option premiums. Although these may seem somewhat difficult, utilising option volatility is not very complicated.

The volatility of an option is to measure the extent of currency price changes over a given period based on historical variable data. Therefore, short-term volatility is significantly reduced compared to long-term volatility if the daily average range of variation is reduced from 100 to 60 and is maintained for about two weeks.

Thus, if EUR/USD shows 100 to 60 daily variations and stays in this range for about two weeks, daily/short-term volatility also narrows to exactly this range compared to weekly/long-term fluctuations over the same period.

 

Principles of Option Volatility

 

1. If the short-term option volatility is lower than the long-term option volatility, the direction is uncertain, but it should be expected to break through the existing range.

2. If the short-term option volatility is higher than the long-term option volatility, it means that regression to the existing range is likely to occur.

This principle is established because the inherent option volatility is lower when the exchange rate moves within the range. We should be most careful when option volatility drops sharply because this time may be on the verge of a breakthrough.

Risk Reversal Strategy helps traders who use the breakthrough strategy as it helps them predict potential breakthrough points. After checking the past range, traders should look at option volatility to determine whether the exchange rate will stay in the range.

Monitoring option volatility will help them to decide when to liquidate positions. If short-term option volatility falls below long-term volatility, traders should consider selling price if the breakthrough does not occur.

 

Macroeconomics Event

 

Many day-traders pay attention to short-term economic indicators that may affect their trading. But, it is also essential to consider macroeconomic events which may move the market. The large scale macro events may potentially influence mid-to-long-term fundamentals for the currencies of the countries.

Events such as wars, political uncertainties, natural disasters, and critical international conferences are unpredictable and irregular, which leads to a ripple effect on the currency market. Depending on these events, the currency may be rapidly strengthening or weakening rapidly.

Therefore, we should pay attention to significant issues around the world. By understanding the market atmosphere before and after the event occurs, we can do successful trading. We can reduce at least the likelihood of severe losses.

 

What Are The Significant Events?

 

 

– G7 Finance Ministers Meeting

– Presidential Election

– Major Central Bank Meetings.

– Possibility of Change in the Monetary System.

– Possibility of Default in Large Countries.

– Possibility of War Development Due to Geopolitical Tensions.

– Fed’s Semi-Annual Speech to Congress.

 

Leading Indicators

 

 

1. Gold

 

Before analysing the relationship between gold and commodity currency, it is vital to understand the relationship between the U.S. dollar and gold in advance. The U.S. is the world’s second-largest gold producer after South Africa, but a rally in gold prices does not lead to a rally in the dollar. When the dollar fell, gold prices often rose, and vice versa. In times of geopolitical instability, investors avoid the dollar and instead choose gold as a safe asset.

Many investors often call gold anti-dollars. Thus, if the dollar weakens, gold prices will gain momentum as many timid investors flock to stable commodities to avoid the depreciating dollar. AUD/USD, NZD/USD, and USD/CHF tend to chase gold price movements like mirrors. This is because each of these currencies has a close relationship with gold naturally and politically.

Commodities such as gold and crude oil are very closely linked to the FX market. Therefore, understanding the nature of the relationship between commodities and currencies would help traders measure risks, predict price changes, and understand the extent of risk exposure.

For investors, commodities may be seen as a completely different concept. Still, in particular, gold and crude oil tend to fluctuate depending on similar fundamentals that drive the FX market. Four currencies are considered commodity currencies: Australian dollars, Canadian dollars, New Zealand dollars, and Swiss francs.

All four currencies are strongly correlated with gold prices. Gold deposits and currency-related laws in these countries affect gold prices, and the money was moving almost like a mirror. The Canadian dollar fluctuates in conjunction with crude oil prices, but their relationship is very complicated. These currencies have a striking correlation with the commodities, and the money movement naturally affects the price of the product. If we grasp this movement and direction, we can quickly identify trends between the two markets.

 

 

2. Oil Price

 

Oil prices have a significant impact on the global economy. Regardless of whether the economic entity is a producer or a consumer, it is affected. Therefore, the correlation between oil prices and currencies is more complex and unstable than gold. The Canadian dollar is the only commodity currency that has a close relationship with crude oil prices.

Because USD/CAD correlates with -0.4, USD/CAD falls when oil prices rally, which means that the Canadian dollar has a bullish trend. Although Canada has the world’s 14th largest crude oil reserves, oil prices are far greater than gold and significantly impact Canada’s economy.

Gold prices do not have a ripple effect on other parts, but oil prices do. Canada has a massive demand for heating oil throughout the year due to the cold weather. Canada’s economy is susceptible when its overseas economic structure is weak because it depends entirely on exports.

Therefore, oil prices have a wide variety of influences on the Canadian dollar. Much of this impact is attributed to changes in U.S. consumer demand due to rising oil prices. Usually, Canada concern about U.S. consumer’s demand when the oil price increases. This is because 85% of Canadian exports are headed to the U.S., closely linked to the Canadian economy.

 

3. Bond Spreads

 

Interest rates are an essential part of investment decisions and determine the market’s direction. The FOMC rate decision is the second most influential employment data indicator that drives the foreign exchange market.

Changes in interest rates determine their long-term direction in currency value. A country’s central bank’s interest rate decision could affect several currencies as currency pairs are closely linked to each other in the FX market. Interest rate differences in bonds such as LIBOR and 10-year fixed-rate bonds can be used as a leading indicator of exchange rate fluctuations.

 

4. Interest Rates

 

The central bank’s decision on overnight interest rates significantly impact exchange rate fluctuations since overseas investors are very sensitive to interest rates. Large investment banks, hedge funds, and institutional investors participate in the global market for asset management. Therefore, they are actively converting funds from low-interest assets to high-interest assets.

In theory, there is an absolute correlation between interest rate differences and exchange rate flows because most foreign exchange traders consider current and future interest rate differences when making investment decisions. 

After referring to various data, we can see that the interest rate spread acts as a leading indicator. If market participants think they are trading on different information rather than just one interest rate variable, it may not be an accurate indicator.

 

 

 

How to Use Carry Trading Strategy

 

 

1. Choose the most powerful currency pairs!

 

Many traders fail to consider the relative strength of both currencies displayed in the exchange rate. Without realising the economic status of currency pairs, it increases the probability of losing the trade.

If the currency pair you are trading belongs to countries with a good economy, the trading is most likely to fail as there is a mere movement. It depends entirely on the change in the relative currency.

Therefore, finding a good currency pair is the first step toward maximising returns. The good currency pair combines the “currency of a country with good economic conditions” and “currency of a country with bad economic conditions.”

The reason is to find a currency pair with strong trending movements. A currency with good economic conditions will increase its currency value. A currency with difficult economic conditions will fall, so the exchange rate movement, which shows the combined effect, will eventually shift in one direction. This can be seen as a trend in the end.

 

2. Carry Trade with leverage!

 

A carry-trade strategy is to sell low-interest monetary assets to form assets as high-interest financial assets. The carry trading strategy using leverage is one of the preferred strategies for global macro hedge funds and investment banks.

Aggressive investors do not hedge against these changes in investment because they can enjoy interest rate differences between the two currencies and bet on the exchange rate appreciation of high-interest currencies.

With leverage, the 2.5% interest rate difference between the two currencies could be 25%, considering the 10-fold leverage. However, leverage is very dangerous because, if not properly managed, we can also magnify losses.

Carry trading is the easiest way to utilise the basic economic principle of demand and supply in the market. Funds will flow into markets that provide the highest return on investment. In other words, a large amount of money flows into high-interest currencies, which increases the demand for their currencies.

These most common carry trades are straightforward to acquire. If you know and approach accurately, you can earn high profits without significant risk. But, carry trade also clearly has other risks. If you don’t understand when, why, or how you can effectively seal the carry trade, you can lose a lot of money.

 

How does the Carry Trade Proceed?

 

 

The way to implement the carry trade is to buy a high-interest currency and sell a low-interest currency on the contrary. Through the carry trade, investors can earn a difference in interest rates or a spread of interest rates between the two currencies.

STEP1: Let’s say the interest rate on the Australian dollar is 5%, and the interest rate on the Swiss franc is 1%.

STEP2: In this case, you can buy Australian dollars and sell Swiss francs to implement carry trade.

STEP3: If the exchange rate between the Australian dollar and the Swiss franc does not change at maturity, 5%-1% = 4% return.

STEP4: This yield is a return without leverage. If 10x leverage is used, it will increase to 40%.

BUY AUD → EARN INTEREST RATE → SELL CHF!

 

HOW TO EXECUTE?

 

STEP1:  BUY AUD/CHF (Buy Australian dollar and sell Swiss franc).

STEP2: Australian dollar buying position: 5% interest income.

STEP3: Swiss franc selling position: 1% interest expense.

STEP4: 4% revenue assuming the exchange rate remains.

If the inflow of investors who have confirmed such opportunities, investors will profit from the exchange rate and the difference in interest rates. Importantly, to carry trade, buy a high-interest currency and sell a low-interest currency is the fundamental idea.

 

How does Carry trade Occur?

 

Carry trade occurs when capital between countries repeats inflows and outflows consistently. Interest rates are a measure of which country is more attractive to investors than in other countries. Countries with the right economic conditions (high growth, high productivity, low unemployment, income improvement, etc.) will give high-profit to those who want to invest in those countries.

In other words, countries with high growth expectations can provide high profits enough to those who support their own countries. Usually, investors look for investments that give them high returns to maximise profits.

Countries with low growth and productivity will not be able to provide high returns to investors. In reality, some countries show poor economic conditions that cannot offer any return on investment, which means that interest rates are zero or close. This difference in interest rates between the two currencies makes it possible to carry trade.

For Example, 

1. If you deposit in Swiss francs, it will give you 1% interest.

2. If you deposit in  Australian dollars, it will give you 5% interest.

3. Australian dollars have a higher interest rate than Swiss francs.

4. Investors sell the Swiss franc and buy the Australian dollar.

5. As a result, a 4% return can be obtained from the purchase of an Australian dollar deposit that pays 5% interest.

This transaction of investors sell Swiss franc and buy the Australian dollar is named carry trading. If many market participants are making these transactions, it will naturally shift capital from Switzerland to Australia to earn interest. This inflow of capital increases demands the Australian dollar, causing the currency to rise. 

 

 

 

More About Carry Trading

 

 

 

1. How Many Risks Should I Take?

 

Investors who actively take risks are said to be high-risk takers or risk-preferred. Conversely, investors who are conservative and willing to take less risk are low-risk takers.

Carry Trading is the most profitable when investors have a high risk-taking tendency.  Buying a currency that pays high-interest rates is eventually taking risks for investors. Risk refers to uncertainty about whether a country’s economy can continue to be in good shape and continue to pay high-interest rates.

There is a possibility that something will happen to stop a country from paying high-interest rates. Consequently, investors are willing to take these risks. If investors are unwilling to accept these risks, capital will not move from one country to another, and the opportunity for Carry Trading will not be there. Therefore, a group of investors must have a high risk-taking tendency or be willing to take risks in investing in high-interest currencies.

 

2. When Should I Stop Carry Trading?

 

Carry Trading is the least profitable when investors have a low risk-taking tendency. When market participants hesitate to invest in high-risk currencies that pay high-interest rates, they invest in safe asset currencies that pay low-interest rates. This shows precisely the opposite direction of Carry Trading, buy low-interest currencies and sell high-interest currencies.

 

 

 

Other Things to Keep in Mind!

 

 

Identifying risk-taking tendencies is an essential part of the carry trade, but this is not necessarily the only consideration. Below are the other things we need to consider.

 

1. The Strength of Low-Interest Currencies

 

By implementing the carry trade, investors can earn profits from the difference in interest rates between high and low-interest rates or spread. However, you may lose earnings if the low-interest currency strengthens for some reason, like a better economic situation. The ideal moment to Carry Trade is when low-interest currency countries have low economic growth forecasts or poor economic conditions.

 

2. Trade Balance

 

The difference between a country’s trade balance, namely exports and imports, also affects Carry Trading’s profitability. In general, if investors have a high risk-taking tendency, capital flows from low-interest countries to high-interest countries, but it is not always the case.

The U.S. currently maintains low-interest rates but attracts a lot of capital from other countries. This is the same, even if investors have a high risk-taking tendency. The reason why this happens is that the U.S. has a considerable trade deficit. Since imports are higher than exports, the United States must import capital from other countries to cover the trade deficit.

The U.S. is attracting foreign capital without a doubt. This illustrates that even if investors have a high risk-taking tendency, an imbalance in the trade balance can cause a rise in the value of low-interest currencies. If the value of low-interest currencies (selling currencies) appreciates, this will negatively affect the carry trade’s profitability.

 

3. Investment Period

 

In general, Carry Trading is a long-term investment strategy. To implement the carry trade, the investor must consider an investment period of at least six months. This investment period is to be taken into account because the carry trade is not affected by the noise generated by short-term exchange rate fluctuations. Also, suppose leverage is not used significantly. In that case, the position can be held for a long time and helps overcome market fluctuations.

 

Overview of Canadian Dollars (CAD)

 

Canada was a resource-based country, and its early economic development depended on the export of natural resources. Canada is currently the world’s fifth-largest gold producer and the world’s 14th-largest oil producer. However, 75% of citizens work in the service sector, accounting for more than 65% of Canada’s GDP.

The Canadian economy began to grow with a weakening Canadian dollar against the U.S. dollar and a free trade agreement on January 1, 1989. The agreement eliminated tariffs on almost all trade between the United States and Canada. As a result, Canada exports more than 78 per cent of its products to the United States.

In January 1994, the North American Free Trade Agreement (NAFTA), including Mexico, abolished most tariffs between the three North American countries. Due to the close trade partnership between the U.S. and Canada, Canada is very sensitive to the U.S. economic situation. If the U.S. economy is unstable, demand for exports to Canada will decrease. The opposite is the same, so exports to Canada will benefit when the U.S. economy is booming.

 

Bank of Canada

Determines Monetary Policy

 

The central bank of Canada is the Bank of Canada (BOC). Monetary policy is determined by the Central Bank of Canada Policy Committee, which consists of one president and six vice presidents. Canada’s central bank holds about eight annual meetings to discuss changes in monetary policy. It also publishes monetary policy reports every quarter.

Canada’s central bank’s goal is to maintain the value of the currency. This means stabilising prices. Inflation targets keep price stability agreed with the Treasury Department. Canada’s central bank believes that high inflation will make the economy difficult. In contrast, low inflation can stabilise prices, which helps achieve sustainable long-term economic growth goals.

The Bank of Canada controls inflation through short-term interest rates. If inflation exceeds the target, Canada’s central bank will implement a tight monetary policy. On the contrary, if inflation falls below the target, Canada’s central bank will ease its monetary policy. Overall, Canada’s central bank has maintained its inflation target very well within the range of 1–3% since 1998.

The Bank of Canada measures currency conditions through the Monetary Conditions Index (MCI). It is calculated by the 90-day commercial bill rate change and the G-10 trade-weighted exchange rate change. Canada’s interest rate-to-exchange weight was set at 3:1 based on historical research and refers to the effect of interest rates and exchange rates on changes in economic conditions.

This means that a 1% short-term interest rate hike has a similar impact as a 3% increase in the trade-weighted exchange rate. Canada’s central bank will adjust bank interest rates to change its monetary policy, which will affect the exchange rate.

If the exchange rate rises to an undesirable level, Canada’s central bank can cut interest rates to limit the rise, and if the exchange rate falls, it can raise interest rates on the contrary. However, it does not adjust interest rates to control the exchange rate but instead uses it as a controlling inflation method. The following are the most common policy measures used by the Canadian central bank to implement monetary policy.

 

1. Bank interest rate

 

This is a significant interest rate that the Canadian Central Bank uses to control inflation, the Commercial Bank of Canada. If the interest rate changes, other interest rates, including mortgage rates and preferential rates, will also be adjusted for commercial banks. Therefore, changes in interest rates will affect the overall economy.

 

2. Open Market Manipulation

 

Large Value Transfer System(LVTS) is an extensive payment system for implementing monetary policy by the Central Bank of Canada. Commercial banks in Canada are borrowing or lending funds through the LVTS to meet their daily funding balance.

LVTS is a computer platform that handles large-scale transactions between financial institutions. Interest rates applied to these daily money transactions are called overnight rates or bank rates. If these overnight interest rates are higher or lower than market interest rates, Canada’s central bank adjusts its lending rates to commercial banks to change the overnight interest rates.

The Bank of Canada regularly publishes several publications, including semi-annual monetary policy reports that assess the impact of current economic conditions and inflation. Quarterly Canadian central bank reports include financial commentary, feature articles, executive committee comments and important announcements.

 

Key Characteristics of Canadian Dollars

 

 

1. Commodity-Related Currency

 

Canada is the world’s fifth-largest gold producer and the 14th-largest oil produce, and the correlation between Canadian dollars and commodity prices amounts to about 60%.

Rising commodity prices generally benefit domestic producers and increase income from exports. It is important to note that increasing commodity prices eventually affect import demand from abroad, such as the United States, resulting in a drop in Canadian exports.

 

2. Strong Connection with the United States.

 

The United States accounts for around 80 per cent of Canada’s total exports. Canada has recorded a surplus in trade with the United States since the 1980s. Therefore, Canada’s economy is susceptible to changes in the U.S. economy.

The economic growth of the U.S. accelerated trading volume with Canadian companies increases, which benefits the Canadian economy. However, if the U.S. economy slows, the Canadian economy will be shocked as U.S. companies cut back on imports.

 

3. M&A

 

Due to the proximity of the United States and Canada, cross-border mergers and acquisitions are widespread as part of an internationalisation strategy pursued by many companies worldwide. This merger and acquisition create a flow of funds between the two countries, ultimately affecting the currency.

 

4. Interest Rate Difference

 

Professional Canadian dollar traders closely monitor the difference between central bank interest rates in Canada and short-term interest rates in other developed countries. These differences can be a good indicator of potential cash flows.

This is because it is possible to determine how much the premium of Canadian short-term bonds is higher than vice versa. As investors are always pursuing high-yield assets, the difference in interest rates between the two currencies is an indicator of traders’ potential currency movements. This is very important for Carrey traders who want to enter or liquidate their positions depending on the interest rate gap between global bonds.

 

5. Carry Trade

 

Carry Trading is to buy or operate low-interest currency assets by selling or borrowing low-interest currency. When Canadian interest rates are higher than U.S. interest rates, the USD/CAD sell-carry trade increases the widespread carry trade opportunity due to their proximity.

Many foreign investors and hedge funds are looking for opportunities to earn high returns, so Carry Trading is very common. If the U.S. implements austerity measures or Canada begins to cut interest rates, the interest rate gap between the Canadian dollar and the U.S. will narrow. In that situation, the Canadian dollar will be under downward pressure if investors start liquidating the Carry Trade.

 

Important Economic Indicators in Canada

 

 

1. Unemployment

The unemployment rate is expressed as a percentage of the unemployed population from the total working population.

 

2. Consumer Price Index

 

CPI represents the average increase in prices. Suppose economists refer to inflation as an economic problem. In that case, this usually means that general inflation levels, which lead to a decline in economic purchasing power, continue to rise over some time. Inflation usually represents an increase in the CPI of the Consumer Price Index as a percentage.

The Canadian inflation policy, determined by the federal government and Canada’s central bank, is based on maintaining inflation within the target range of 1–3%. If inflation is 10 per cent per year, the purchase value of $100 last year will average $110 this year, and if the same inflation conditions are the case in the coming years, it will cost $121 to purchase.

 

3. Gross Domestic Product

 

Canada’s GDP is the sum of all goods and services produced in Canada over a year. This also means income from goods and services produced in Canada. Because GDP represents the gross product, only the final output of goods and services is aggregated except for intermediate goods to avoid duplicate calculations. For example, wheat used to make bread is not included in the GDP tally because it is an intermediate product, but only the final bread is included.

 

4. Trade Balance

 

The balance of trade represents the trade history of goods and services in a country. It includes the exchange of products, raw materials, agricultural products, travel, and transportation. The trade balance is a difference between the total amount of goods and services exported by Canada. If Canadian exports exceed imports, it is a trade surplus, and the trade balance represents a plus. If imports exceed exports, they are in the trade deficit, and the trade balance is negative.

 

 

5. Producer Price Index

 

The producer price index PPI is an index group that measures the average change in domestic producers’ selling price. The PPI tracks prices in most production industries in the domestic economy, including agriculture, electronics, natural gas, forestry, fisheries, manufacturing and mining. The foreign exchange market watches how the PPI and PPI indexes of seasonally adjusted final goods have changed monthly, quarterly, semi-annual, and year-on-year.

 

6. Consumer Spending

 

It is a national account that measures expenditure by stores and consumption by individual non-profit operators for households. Spending includes purchasing durable goods as well as non-durable goods. However, it does not include individual home purchase expenditure and private entity capital expenditure.

Overview of New Zealand Dollar

 

New Zealand has been one of the most regulated countries in OCED, but it has been aiming for an open, modern and stable government for the past 30 years. Following the Fiscal Responsibility Act 1994 of the Fiscal Responsibility Act, New Zealand has shifted from agricultural countries to knowledge-based economies with a high level of technology and full-employment.

The law establishes legal standards that support the government’s official responsible for financial management and shows a macroeconomic policy system in New Zealand. New Zealand has been highly developed in the manufacturing and service sectors and agriculture, which leads to most of its national exports. New Zealand is a trade-oriented country, with commodity exports and service trade accounting for about one-third of GDP.

New Zealand is highly sensitive to global economic conditions, especially those of its major trading partners, Australia and Japan, because of its small economy and large trade volume. New Zealand’s GDP shrank 1.3% during the Asian crisis. This is attributed to decreased agricultural and agricultural-related production and decreased exports and demand due to two consecutive years of drought. New Zealand’s most important trading partners are:

 

The Reserve Bank of New Zealand (RBNZ)

Determine Monetary Policy

 

The Reserve Bank of New Zealand (RBNZ) is the central bank of New Zealand. The Monetary Policy Committee is an in-bank committee that reviews monetary policy every week. Monetary policy-making meetings are held eight times a year, or almost every six weeks. Unlike other central banks, interest rate adjustments are ultimately decided by the bank president. The minister and the governor determine the current policy objective agreement and focus on maintaining policy stability to avoid the gross product, interest rates, and exchange rates.

Price stability aims to maintain 1.5% of annual CPI. This situation is unlikely to occur if RBNZ fails to achieve this goal, but the government could dismiss the RBNZ president. This strongly encourages RBNZ to achieve its inflation target. The most common tools used by RBNZ to implement monetary policy changes in interest rates.

Key Characteristics of New Zealand Dollars

 

1. Strong association with AUD

 

Australia is New Zealand’s largest trading partner. Along with its positional proximity, New Zealand is a trade-oriented country that has created a strong bond between the two countries economies. New Zealand is the first country to suffer flood damage when Australia’s economy is booming, and Australian companies increase their export activities. In fact, since 1999, Australia’s economy has been booming due to a housing market boom that has led to increased demand for building materials. As a result, Australia’s imports to New Zealand increased by 10% between 1999 and 2002.

 

2. Product-related currency

 

New Zealand is a commodity-export-oriented country where exports of goods account for more than 40% of its exports. This created a 50% definition correlation between the New Zealand dollar and the commodity price. When commodity prices rise, the New Zealand dollar gains an upward trend.

The New Zealand dollar status as a commodity-related currency links the Australian dollar and the New Zealand dollar. The correlation between commodity prices and the New Zealand dollar is not limited to New Zealand’s trade activities but is also deeply related to the Australian economy’s performance.

Since the Australian economy’s performance is also deeply related to commodity prices, rising commodity prices will benefit the Australian economy and increase economic activity across national operations, including trade with New Zealand.

 

3. Carry Trade

 

New Zealand has one of the highest interest rates among developed countries. The New Zealand dollar has traditionally been considered one of the most valuable currencies for the Carrey trade purchase. Carry trading is buying or operating low-interest currency assets by selling or borrowing low-interest currencies. With many global investors looking for investment destinations to earn high profits, Carrie Trading’s popularisation has created a rise in the New Zealand dollar.

However, this also made the New Zealand dollar very sensitive to interest rate fluctuations. If New Zealand maintains or cuts interest rates while the U.S. raises interest rates, the New Zealand dollar’s Carrey’s merit will decrease. In this situation, the New Zealand dollar will be under downward pressure if investors liquidate their Carrie trade positions.

 

4. Interest rate difference

 

Professional NZD traders closely watch the difference in interest rates between New Zealand’s interest rates and other advanced countries’ interest rates. The difference in interest rates is a good indicator of potential currency flows because it can determine the extent to which the premium of New Zealand’s short-term bonds is higher than or vice versa.

Because investors are always looking for high-yield assets, this difference indicates potential currency movements for traders. This is especially important for Carrey traders who want to enter or liquidate their positions depending on the interest rate gap between global bonds.

 

5. Population movement

 

New Zealand’s population is less than half of New York’s population. As a result, New Zealand’s economy can be significantly affected by the increase in immigrants to New Zealand immigrants. New Zealand population increased by 1,700 between 2001 and 2002, while that of New Zealand increased by 160,000 between 2006 and 2997.

It looks small, but it is significant for New Zealand. Immigration to New Zealand contributes quite a bit to economic performance. This is because as the population increases, demand for daily necessities increases and overall consumption increases.

 

6. Drought Impact

 

Since most of New Zealand’s exports are goods, New Zealand’s GDP is very sensitive to extreme weather conditions that damage agricultural activity. In 1998, the national expenditure from the drought exceeded 50 trillion won. Moreover, droughts often occur in Australia, New Zealand’s largest trading partner. The drought will result in losses of more than 1% of Australia’s GDP, which will negatively impact New Zealand’s economy.

 

Significant economic indicators in New Zealand

 

New Zealand does not often publish economic indicators, but the following indicators are critical.

 

1. Gross Domestic Product

 

GDP is the sum of the market value of all goods and services produced in New Zealand. GDP is calculated, including expenditure by households, businesses, governments, and net foreign purchases. The GDP deflator is used to convert the gross output measured at the current price to fixed dollar GDP for the base year.

This indicator is used to determine the current location of the New Zealand business cycle. High rates of success are often interpreted as inflation, and low growth rates suggest a recession or sluggish economic growth.

 

2. Consumer Price Index

 

The Consumer Price Index CPI measures changes in prices of goods and service baskets every quarter, which account for a high percentage of expenditures by the CPI sample group. This basket includes a wide range of goods and services, including food, housing, education, transport, and health. Monetary policy is an important indicator because it is based on this index, a measure of inflation.

Overview of Australian Dollars (AUD)

 

Australia is the fifth largest country in the Asia-Pacific region by GDP. Although the economy is relatively small, it is comparable to Western European countries by GDP per capita. It is a service-oriented country, with 79 per cent of GDP generated by the financial, real estate and corporate services industries. However, Australia is under a trade deficit with a high proportion of manufacturing exports in which commodity exports account for more than 60%.

As a result, the entire economy is sensitive to changes in commodity prices. Analysis of trade partners is important because Australia’s major trading partners’ economic downturn or rapid growth greatly affects Australia’s import and export demand. Japan and ASEAN are the most important importers of Australian goods. The Association of Southeast Asian Nations includes Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, the Philippines, Singapore, Thailand, and Vietnam.

Australia maintained strong growth by solidifying the foundation of “strong domestic consumption” and was able to withstand the past economic crisis. Consumption has been steadily increasing since the 1980s. Therefore, consumer spending is an important economic indicator that should be watched as a signal to confirm the impact of the economic slowdown on Australia’s domestic consumption during the global economic downturn.

 

Reserve Bank of Australia

Determines Monetary Policy

 

The Reserve Bank of Australia (RBA) is the central bank of Australia. The Monetary Policy Committee determines monetary policy to achieve the targeted goals.

The government has set an unofficial consumer price inflation target at an annual rate of 2 to 3 per cent. The RBA believes that the key to sustainable economic growth in the long term is inflation control, which maintains proper monetary value.

Inflation targets also provide rules for determining monetary policy and provide guidelines for private-sector inflation expectations. This increases transparency in central bank policies. If inflation or inflation expectations exceed 2 to 3 per cent, traders will expect the RBA to implement a tight monetary policy.

Monetary policy decisions include setting the overnight lending rate in the currency market. Borrowers and lenders in financial markets are affected by these monetary policies (but not just by monetary policy) because changes in overnight lending rates affect various other interest rates.

1. Central Bank Interest Rate

 

The central bank interest rate is the RBA’s target for open market manipulation. This interest rate is on overnight loans between financial institutions, which is closely related to market capitalization. Changes in monetary policy directly affect the financial system’s structure and affect the value of the currency.

 

2. Interest Rate Maintenance – Open Market Manipulation

 

The purpose of open market manipulation is to keep the central bank’s interest rate close to the target by providing liquidity to commercial banks. If the central bank wants to cut interest rates, it could increase the supply of short-term repurchase agreements at lower interest rates than general interest rates. If the central bank wants to raise interest rates, it will raise interest rates by reducing the supply of short-term repurchase agreements.

The redemption agreement is a transaction in which the commercial bank sells the securities to the RBA after agreeing to buy the same amount of securities again on the specified date in the future. This structure is similar to a mortgage and Repo deals have very short maturities from one day to a few weeks.

Australia introduced a floating exchange rate system in 1983. RBA can intervene in the exchange rate market if market volatility increases excessively. RBA observes the trade price index and the cross-exchange rate with the dollar closely. Market intervention is aimed at stabilizing the market environment rather than achieving the goal of the exchange rate.

 

3. Monetary Policy Conference

 

The RBA discusses potential changes in monetary policy on the first Tuesday of each month except January. After all meetings, it issues a press release explaining the justifiable reasons for the change in monetary policy and releases a statement regardless of whether interest rates change.

The RBA publishes semi-annual monetary policy statement in May and November. And on February, May, August and November quarterly reports on the economy and financial markets are published. These reports are recommended to be scrutinized as you can detect potential signs of monetary policy change.

 

 

Key Characteristics of Australian Dollars

 

 

 

1. Product-Related Currency

 

Historically, the Australian dollar has had a strong relationship with commodity prices, especially gold prices, reaching nearly 80 per cent. This stems from the fact that Australia is the world’s third-largest gold producer. As a result, the Australian dollar benefits when commodity prices rise, but the Australian dollar also falls when commodity prices fall.

Higher commodity prices will heighten inflation concerns, and the RBA will raise interest rates to curb inflation. However, gold prices tend to rise in the age of uncertainty in the global economy or political issue. If the RBA raises interest rates in this situation, Australia will be more vulnerable to uncertainties.

2. Carry Trade Effect

 

The Australian dollar is most commonly used in-carry trading because of its high liquidity and interest rate. Carry trading is the purchase of high-interest monetary assets by selling or borrowing low-interest currencies. The Australian dollar rose 95 per cent against the U.S. dollar from 2001 to 2007.

Many foreign investors have been looking for high-yield investments when the return on the stock investment is low. Carry trade will continue as long as there are opportunities. If global central banks raise interest rates and the interest rate gap narrows between Australia and other countries, AUD/USD will be hit by the carry-trade liquidation.

 

3. Drought Impact

 

As commodities account for most of Australia’s exports, Australia’s GDP is very sensitive to the climate environment that damages agricultural activity. For example, 2002 was a challenging year for Australia to find a severe drought, and it hit the Australian agricultural sector tremendously.

Agriculture is vital as it accounts for 3% of Australia’s GDP. The RBA estimates that a decrease in agricultural production could directly reduce GDP growth by 1%. In addition to exports, the drought has indirectly affected other aspects of Australia’s economy. Retail operations in rural areas and industries that provide services to agriculture, such as wholesale and transportation sectors, are negatively affected by drought.

However, it is worth noting that Australia’s economy is showing strong growth right after the drought. The 1982–1983 drought initially reduced GDP, but then increased by 1 to 1.5%. The 1991–95 drought caused GDP to fall 0.5–0.75% in 1991–92 and 1994–95 but eventually rose 0.75%.

 

4. Interest Rate Difference

 

Professional traders in the Australian dollar are watching the difference between interest rates in Australia and short-term interest rates in other developed countries. This is because the premium of Australian dollar short-term bonds can be determined to what extent they are higher or vice versa than short-term bonds. These differences can be a good indicator of potential changes in currency value.

Traders use this difference to indicate potential currency movements because investors are always looking for high-yield assets. This is especially important for carry-traders who want to enter or liquidate their positions depending on the interest rate gap between global bonds.

 

Australia’s Important Economic Indicators

 

 

1. Gross Domestic Product

 

Gross domestic product is the sum of the market value of all goods and services generated in Australia. GDP is calculated by households, businesses, governments, and net foreign purchases (export-income). The GDP deflator is used to convert the total output measured at the current price to the base year’s fixed-dollar GDP. This indicator is used to determine the Australian business cycle’s current location, where high growth rates are often interpreted as inflation, and low or negative growth suggests economic recession or sluggish economic growth.

 

2. Consumer Price Index

 

The Consumer Price Index CPI measures changes in the prices of goods and service baskets every quarter, which account for a high percentage of expenditures by the CPI population sample group (such as large urban households). The basket includes a wide range of goods and services, including food, housing, education, transport, and health. CPI is an important indicator because it is determined based on this index, a measure of inflation.

 

3. Balance of Goods and Services

 

The index is a measure of Australia’s international trade in goods and services based on its balance of payments. The import and export of general goods are mostly derived from international trade statistics based on Australian tax records. The current account is the trade balance plus the service balance.

 

4. Personal Consumption

 

 This includes purchasing durable goods as well as non-durable goods. However, it does not include expenditure on housing purchases and capital expenditure on private entities. It is important to watch because personal consumption can drive the recovery of the Australian economy.

 

5. Producer Price Index

 

The Production Price Index PPI is an index group that measures the average change in domestic producers’ sales prices. The PPI tracks price changes in almost all commodity-producing industries in the domestic economy, including agriculture, electronics, natural gas, forestry, fishing, manufacturing, and mining.

The foreign exchange market focuses on how the seasonally adjusted PPI and PPI indexes have changed from monthly, quarterly, semi-annual, and year-on-year. Australia’s PPI is published quarterly.

Overview of Japanese Yen

Japan is the world’s third-largest economy after the United States and the second-largest economy as a single country. Japan is also the world’s largest exporter and has more than $500 billion in exports every year.

Manufacturing, electronics, and automobiles are critical drivers of the economy, with production and exports reaching 20 per cent of GDP. Despite Japan’s severe structural flaws, it has maintained a trade surplus, creating demand for the Japanese yen.

Also, Japan is one of the largest importers of raw materials to produce goods. In both import and export, Japan’s most important trading partners are the United States and China.

Japanese Asset Bubble

 

To understand the Japanese economy, we first need to determine what caused Japan’s asset bubble and burst. In the 1980s, Japan’s financial market was one of the most attractive international investors in Asia. Japan had the most advanced capital markets in Asia, and its banking system was considered one of the most powerful countries in the world.

At that time, Japan had high economic growth and zero inflation. This resulted in rapid growth and credit expansion due to rising asset prices, which led to a bubble in asset prices. Then between 1990 and 1997, asset prices fell, causing the asset bubble to collapse. During this period, asset prices fell by more than $10 trillion, of which 65 per cent fell, equivalent to Japan’s two-year domestic production.

The drop in asset prices triggered the Japanese financial crisis. The financial crisis began in the early 1990s and reached its peak in 1997 when many financial institutions went bankrupt. At the height of the asset bubble in the 1980s, many banks and financial institutions expanded their loans from builders and real estate developers on land as collateral.

However, when the asset bubble collapsed, many real estate developers went bankrupt, forcing financial institutions to embrace bad loans, with collateral falling by 60 to 80 per cent from the initial loan. With the influence of substantial bad debts and corporate loans from Japanese financial institutions, this crisis has dramatically affected the Japanese economy and the global economy. Huge bad loans, a plunge in stock prices and a collapse in the real estate sector seriously damaged Japan’s economy for nearly two decades.

In addition to the financial crisis, Japan’s public debt is more than 140 per cent of GDP, the highest among advanced countries. Japan had suffered a severe economic slowdown for more than a decade due to worsening fiscal conditions and rising public debt.

Japan is still in a liquidity crisis due to the high debt burden, and the financial sector relies heavily on government relief measures. As a result, the Japanese yen is highly sensitive to government statements, implementing relief measures and other rumours about potential changes in the currency’s fiscal policy and political situations.

 

Bank of Japan Determines Monetary Policy

 

The Bank of Japan(BOJ) is an organisation that determines Japan’s crucial monetary policy. In 1998, the Japanese government granted the Bank of Japan to complete control of monetary policy and independence from the Finance Ministry. Despite being the government’s lower authority, the Finance Ministry is still in charge of exchange rate policies. The Bank of Japan conducts foreign exchange transactions in Japan with official responsibility under the Ministry of Finance’s control.

The monetary policy meeting will be held twice a month with briefings, and a press conference will be held immediately after the meeting. The Bank of Japan publishes monthly reports and monthly economic reports issued by the Policy Board. As the Japanese government continues to try new plans to boost the economy, these reports are essential to identify changes in the Bank of Japan’s sentiments and new monetary or fiscal policy signals.

The Ministry of Finance and the Bank of Japan are critical organisations that can lead to currency movements. It is essential to watch the finance ministry officials’ statements because they are in charge of intervention in the exchange rate. Since Japan is an export-oriented country, the government prefers to weaken the yen.

Therefore, if the Japanese yen rises rapidly against the dollar, the Bank of Japan and its Finance Ministry members will express concern about the Japanese yen’s current movement, and remarks are also a variable factor that drives the market. But, if the remarks end up only with actionless verbal intervention, the market will become immune to them.

There are cases in which the Finance Ministry and the Bank of Japan have intervened in the currency market to adjust Japan’s exchange rate. Therefore, we cannot ignore their remarks completely. The most commonly used tool for the Bank of Japan to control monetary policy is open market manipulation.

 

Open Market Manipulation

 

These activities focus on controlling unsecured overnight call rates. For some time, the Bank of Japan has maintained a zero interest rate. This means that the Bank of Japan can no longer cut interest rates to boost growth, consumption or liquidity. Therefore, the Bank of Japan is controlling liquidity through open market manipulation to maintain zero interest rates.

BOJ adjusts liquidity by buying or selling short-term bonds, repos or Japanese government bonds. A repo transaction is a transaction in which a borrower sells securities to a borrower after agreeing to resell the same number of securities as the same stock on a later designated date. This structure is similar to a bond-backed loan in which the borrower pays interest to the borrower. Repo deals have very short maturities from one day to a few weeks.

In terms of fiscal policy, the Bank of Japan has considered several ways to deal with bad debts. This includes targets for inflation, nationalisation of some private banks, readjustment of bad bank debts and discount sales. There was no policy decision, but the government is actively considering many other alternatives.

 

The Main Characteristics of the Japanese yen

 

1. Substitute for Measuring Asia’s Strength.

 

Japan is considered a substitute for measuring the overall strength of the Asian market because it has the highest GDP in Asia. Japan, which has the most developed capital market in Asia, was once a great investment destination for investors who wanted to invest in Asia. Japan also has significant trade exchanges with other Asian countries. As a result, economic and political instability in Japan has many ripple effects on other Asian countries.

Of course, the aftermath is not one-sided. Economic and political issues in other Asian countries also significantly impact the Japanese economy and the Japanese yen. For example, Japan, the G7 country, has strong ties with North Korea, and political instability in North Korea poses a massive risk to Japan and the yen.

 

2. Implementation of Bank of Japan intervention

 

Japan is a very political country with close ties with government officials and large private institutions, so Japan’s Finance Ministry is mindful of large private institutions trying to stop the yen from strengthening.

The Bank of Japan is an active intervention participant, harmonising with market movements and other participants. The Bank of Japan is likely to intervene when it regularly receives loan information from banks on prominent hedge fund positions and holds positions different from the market to generate speculative profits from speculators. 

 

2. Japanese Yen’s Movement is Time-Sensitive.

 

Speculators buy yen to earn profit from the Japanese yen’s rise in anticipation of increased demand for yen purchases from home-country transfers at the end of the fiscal year (31 March). As a result, after the fiscal year, the Japanese yen tends to decline due to its liquidation by speculators.

Except for the fiscal year, the time element is also a significant consideration daily. Unlike traders in London and New York, who usually have lunch at trading desks, Japanese traders have an hour lunch break from 10 p.m. to 11 p.m., New York time. Therefore, due to the market’s lack of liquidity, volatility may increase during lunchtime in Japan.

Also, the Japanese yen tends to move in an orderly manner in the Japanese and London markets unless important announcements, remarks by government officials, or economic indicators are surprising. However, in the New York market, the Japanese yen’s volatility increases as U.S. traders actively trade dollars and yen positions.

 

3. Pay Attention to Bank Stocks.

 

Participants in the foreign exchange market need to observe the banking sector’s shares closely, as the core of the Japanese economic crisis stems from the bad debt of Japanese banks.

Banks’ default threats, poor performance, or additional occurrences of bad loans suggest that the economy has severe problems. Therefore, the movement of bank stocks leads to the direction of the Japanese yen.

 

4. Carry Trade Effect

 

Carrie Trading has recently become popular as investors actively seek high-yield assets. Since Japan has the lowest interest rate among advanced countries, the Japanese yen is mainly a currency sold or borrowed from Carry Trading.

The most popular carry trade calls include GBP/JPY, AUD/JPY, NZD/JPY and USD/JPY. Carry traders buy high-yield currencies and sell the Japanese yen.

Therefore, the liquidation of the carry trade due to the narrower spread causes the Japanese yen to rise. Its liquidation involves selling other currencies and buying the Japanese yen.

 

 

Important Economic Indicators of Japan

 

The following are important economic indicators for the Japanese yen. It is essential to focus on the manufacturing sector figures because Japan is a manufacturing-oriented country.

 

1. Gross Domestic Product

 

Gross Domestic Product is calculated quarterly and annually as the sum of the market value of all goods and services generated in Japan. GDP is calculated, including expenditure by households, businesses, governments, and net foreign purchases (export-income).

The GDP deflator is converted to fixed dollar GDP for the base year of gross output measured at the current price. This indicator is used to determine the Japanese business cycle’s current location, and reserves are of paramount importance to participants in the foreign exchange market.

 

2. A Single-Column Survey

 

This survey is a short-term economic survey conducted by Japanese companies four times a year. It surveys more than 9,000 companies classified as four major (major, large, medium and small enterprises). Foreign exchange market participants widely observe it as it provides an overall business environment in Japan.

 

3. An International Balance of Payments

 

 

The balance of payments provides investors with information about Japan’s international economic transactions, including goods, services, investment income, and capital flows.

The current account balance of the Bank of Japan is used as a helpful measure for determining international trade levels and is announced monthly and semi-annual.

 

4. Employment

 

Employment figures are reported every month by the Japanese Health, Labor and Welfare Administration. Employment indicators measure Japan’s employment-population and unemployment rate, calculated by statistical surveys of the current working population. 

 

5. Industrial Production Index

 

The industrial production index measures the production trends of Japanese manufacturing and utility companies. It is consist of the total quantity of produced goods for domestic sales and overseas. Meanwhile, the index does not include agriculture, construction, transportation, telecommunications, trade, finance, and service industries.

Industrial production is calculated by weights of the relative importance of each element over some time. Investors can use the industrial production index and quantity of inventory accumulation as a piece of good information on the economic status of Japan.

The Overview of Swiss francs (CHF)

Switzerland has a prosperous economy, the highest GDP per person, and higher stability than many other economies. Its wealth depends primarily on technology, tourism and finance in manufacturing.

With its history of chemical, pharmaceutical, industrial, mechanical, instruments along with clocks, and investor confidentiality, Switzerland and the Swiss currency gained a reputation as safe-havens, making it the world’s largest offshore asset destination.

Switzerland has more than $2 trillion in offshore assets and is estimated to account for more than 35% of the world’s private asset management business. As a result, the highly developed large-scale financial and insurance industries have developed, with more than 50% of Switzerland’s population engaged, accounting for more than 70% of total GDP.

Switzerland’s financial industry has flourished with its status as a haven and strict customer confidentiality. Therefore, when there is a strong global tendency to hedge, the inflow of funds leads the economy, and when the tendency to take risks increases, trade leads the economy.

 

Swiss National Bank to Determine Monetary Policy

 

The Swiss National Bank of Switzerland (SNB) is an independent central bank that determines Switzerland’s monetary policy. The committee consists of a chairperson, a vice-chairperson, and other members of the SNB Executive Committee. All decisions are made based on an agreed-upon vote because of the number of people involved.

The Commission reviews monetary policy at least once every quarter, but monetary policy can be determined and published at any time. Unlike most central banks, the SNB does not set an official interest rate target. Instead, it has set a target range for the three-month Swiss Ribo rate.

The SNB set its target at the currency target of M3 but shifted to an annual inflation rate of 2%  in December 1999. The monetary target is still an important indicator, which provides information about long-term inflation, so the central bank is monitoring it intensively.  The central bank has made it clear that SNB will implement monetary tightening policies if mid-term inflation exceeds 2%. If deflation concerns are raised, the central bank will ease monetary policy.

SNB also closely monitors the exchange rate. The excessive strength of the Swiss franc could cause an inflationary environment. Judging from the fact that the global risk-averse trend will lead to a significant increase in capital flows to Switzerland, which could trigger a strong Swiss franc.

Eventually, if this situation arrives, it will intervene without delay in the market through liquidity control to prevent the exchange rate from strengthening. Finally, SNB intervenes in the Swiss franc market through various ways such as verbal intervention, currency supply, and exchange rate.

 

Central Bank Policy Instruments

 

The most common means of the policy used by SNB to implement monetary policy are as followings:

 

1. Target Interest Rate Range

 

The SNB implements monetary policy by setting a target range of three-month interest rates (Swiss Ribo Rates). This range is usually set to a 100BP spread difference and is modified at least once every quarter. This rate is used as a target because it is the most critical market interest rate for investment in Swiss francs. Modifying this target range involves a solid explanation of changes in the economic environment.

 

2.  Open Market Manipulation

 

Repo trading is SNB’s primary monetary policy instrument. A repo trading in which the borrower sells the securities to the borrower after agreeing to reversely trade the same number of securities as the same stock on a later designated date. This structure is similar to securities-backed loans in which borrowers now pay interest to borrowers.

A repo deal has a very short maturity, from one day to a few weeks. Suppose the three-month revolving rate rises above the target set by the SNB. In that case, the central bank will provide additional liquidity to commercial banks at low-interest rates through repo trading. In other words, it supplies money to the market in the form of buying bonds from commercial banks and paying cash. On the contrary, SNB can increase the repo rate to reduce liquidity or induce a three-month rise in the ribo rate.

The SNB issues quarterly self-reports that reviewed a detailed assessment of current economic conditions and monetary policy. The monthly self-report includes a brief commentary on the economic situation. These reports include information on changes in SNB’s assessment of the current domestic economic situation, which needs to be looked at.

 

Key characteristics of Swiss Francs

 

 

1. Status as a Haven.

 

This is probably a unique characteristic of the Swiss franc. Switzerland’s safety shelter status and the secrecy of the banking system are always emphasised because they are the most important advantages of the Swiss financial industry. Swiss francs usually move according to overseas events rather than domestic economic conditions.

This is because the Swiss franc is considered the world’s best safe currency due to its political neutrality. Investors think of the stability of investment assets before the return on investment when global instability or uncertainty is highlighted. In this situation, if funds flow into Switzerland, the Swiss franc will be substantial regardless of the economic status in Switzerland.

 

2. Swiss Francs are Highly Correlated with Gold.

 

Switzerland is officially the world’s fourth-largest gold holder. The Swiss Constitution stipulates that 40% of monetary reserves should be held in gold. Despite the disappearance of the regulation, the relationship between gold and Swiss francs is deeply in the minds of Swiss investors.

As a result, the Swiss franc correlates nearly 80% with gold. When gold prices rise, Swiss francs are also likely to increase. Gold and Swiss francs are also vital in times of heightened global economy and geopolitical uncertainty, as gold is considered the surest haven to replace the currency.

 

3. Carry Trade Effect

 

 

The phenomenon of investors’ preference for high-yield assets has recently become commonplace, and the size has soared. In other words, carry trading is buying or operating low-interest currency assets by selling or borrowing low-interest currencies.

Because the interest rate of Swiss francs is the lowest among advanced currencies, the currency borrowed or sold by carry trading in Swiss francs. This will result in buying a high-interest currency and selling  Swiss francs, a low-interest currency. 

 

4. Follows Price Difference Between Euro Swiss Futures and Foreign Interest Rate Futures.

 

Professional Swiss traders are keeping an eye on the price gap between the three-month Euro-Swiss futures and the Euro-dollar futures. This difference is a good indicator of potential currency flows because it can determine to what extent the premium of U.S. bonds is higher than or vice versa than that of Swiss bond assets in Switzerland.

Investors are always pursuing high-yield assets, so this difference shows traders the potential currency movements. This is especially important for carry-traders who want to enter or liquidate transactions by taking advantage of the interest rate gap between global bonds.

 

 

5. Potential Changes in Bank Regulations

 

Over the past few years, European Union countries have put considerable pressure on Switzerland to ease secrecy in the banking system and increase transparency in customer accounts. The EU has continued to press Switzerland as part of its aggressive efforts to investigate tax evaders in the EU, which will be of great interest in the future.

This is not an easy decision for Switzerland. The secrecy of customer accounts was a key strength of the Swiss banking system. The EU has threatened to impose severe sanctions if Switzerland fails to comply with the proposal. Negotiations are currently underway between related government agencies to find a more appropriate solution. This change in Swiss financial regulations will affect the Swiss franc as well as the Swiss economy.

 

6. M&A

 

The primary industries of Switzerland are banking and finance. Mergers and acquisitions in this industry are widespread throughout the industry, resulting in a significant impact on the Swiss franc.

If a foreign company acquires a Swiss bank or insurance company, they will have to buy Swiss francs and sell their currency, while if a Swiss bank acquires a foreign company, they will have to sell Swiss francs and buy foreign currency. Either way, Swiss franc traders should pay close attention to M&A announcements related to Swiss companies.

 

7. Trading Movement, Cross-Call Characteristics.

 

EUR/CHF is the most actively traded currency pair for traders who prefer to trade CHF. USD/CHF has relatively few transactions due to its lack of liquidity and high volatility. However, day traders tend to prefer USD/CHF to EUR/CHF because of its volatility.

In fact, USD/CHF is only a synthetic currency derived from EUR/USD and EUR/CHF. Market makers and professional traders often use these currency pairs as a leading index to make USD/CHF trading. In theory, the USD/CHF exchange rate is the same as the EUR/CHF divided by EUR/USD.

However, its own USD/CHF transactions will only become active during the global hedging trend, such as the Iraq War and the September 11 terrorist attacks. Market participants quickly take advantage of these fine-grained differences in exchange rates to make profits.

 

Important economic indicators in Switzerland

 

1. KoF (Swiss Economic Research Institute) Leading Index

 

The Swiss Economic Research Institute publishes the KoF’s leading economic index. It is commonly used as a measure of the future health of the Swiss economy.

 

 

2. Consumer price index

 

 

The Consumer Price Index is calculated every month based on retail prices paid in Switzerland. Products selected under general international practice are divided by consumption concepts.

The product basket does not include previous expenditures such as direct taxes, social security, and medical insurance and is an essential measure of inflation.

 

3. Gross Domestic Product

 

GDP is the sum of all goods and services produced and consumed in Switzerland. GDP is calculated, including households, businesses, governments, and net foreign purchases (export-income). 

These indicators are used to determine the current location of the Swiss business cycle. For example, high growth rates are often considered inflation, and low growth suggests a recession or sluggish economic situation.

 

4. Balance of payments

 

The balance of payments is a systematic breakdown of all economic transactions conducted with other countries. The current account is the trade balance plus the service balance.

Switzerland has always maintained a sound current account, so the international balance of payments is an essential indicator for Swiss franc traders. Favourable or unfavourable changes in the current account result in significant changes in the exchange rate.

 

5. Production Index (Industrial Production)

 

The Industrial Index is a measure of changes in quarterly industrial output (or actual production by producers).

 

6. Retail Sales

 

Retail sales in Switzerland are announced every month after 40 days of the month. This is an important indicator of consumer spending and is not seasonally adjusted.

 

The Overview of British pounds (GBP)

 

The UK, the world’s fourth-largest economy with the most efficient central bank globally, has long benefited from high growth, low unemployment, increased output, and a recovery in consumption. 

Britain is a service-oriented country, with the manufacturing sector accounting for less GDP and now accounting for one-fifth of its production. Meanwhile, It has one of the most advanced capital market systems globally, and the financial industry is the most significant contributor to the UK’s GDP.

Although the service industry accounts for most of the GDP, we should not overlook that Britain is one of the largest natural gas producers and exporters in the EU. Energy production accounts for 10 per cent of the UK’s GDP, the highest among developed countries. Rising energy prices, such as oil prices, are critical because they bring significant British oil exporters returns.

Overall, the UK is a net importer with a continuing trade deficit. The largest trading partner is the EU, and bilateral trade accounts for more than 50% of the UK’s total imports and exports. As a single country, the United States is Britain’s largest trading partner. 

 

BOE Determines Monetary Policy

 

 

The nine-member Monetary Policy Committee consists of the president, two vice presidents, two BOE directors, and four outside experts, determining the monetary policy. The Commission approved the independence of monetary policy operations in 1997.

Despite this independence, BOE’s monetary policy focuses on achieving inflation targets by the Minister of Finance. BOE has the authority to adjust interest rates within its permissible range to accomplish this goal. The Monetary Policy Committee shall determine changes in monetary policy, including changes in interest rates, through monthly meetings and announce the details thereof.

The Monetary Policy Committee states all meetings, along with a quarterly inflation report describing the Monetary Policy Committee’s outlook on growth, inflation and legitimacy of policy changes over the next two years.

Other quarterly publications provide information on analysing the past monetary policy movements, the international economic environment, and the impact on the UK economy. All reports include details of the Monetary Policy Committee’s policies and future policy movements.

 

The primary means of the policy used by the Monetary Policy Committee and the Bank of England are as follows:

 

1. Bank Repo Rate

 

This is the primary interest rate used to implement monetary policy that meets the treasury’s inflation target. This interest rate is set for banking operations in markets such as short-term loans from banks.

Change in interest rates affects interest rates charged by commercial banks for depositors and borrowers. This will affect economic spending and production, and consequently, costs and prices—the rise in interest rates to lower inflation will stimulate growth and expand the economy.

 

2. Open Market Manipulation

 

Open market manipulation is implemented by adjusting the repo as mentioned above rates and ensuring adequate liquidity in the market and continuous stability in the banking system.

This reflects the Bank of England’s three main objectives: maintaining the value of the currency, maintaining the strength of the financial system and securing the efficiency of UK financial services.

BOE implements open market manipulation that controls liquidity by buying or selling short-term bonds every day. If this is not enough to manage liquidity, BOE can perform additional Overnight operations.

 

 

The Main Characteristics of the Pound

 

 

1. GBP/USD is highly fluid.

 

GBP/USD is one of the most volatile pairs of currencies, with the British pound accounting for 6% of all pound-related foreign exchange transactions in the world, the benchmark or relative currency. It is also one of the four most volatile currency pairs (EUR/USD, GBP/USD, USD/JPY and USD/CHF) in the foreign exchange market.

One of the reasons for the high liquidity of GBP/USD is the highly developed UK capital market. Many foreign investors who sought investment opportunities outside the United States have invested money in the United Kingdom. Foreigners must sell their currency and buy British pounds for British investment.

 

2. GBP has many speculators.

 

The British pound was one of the currencies with the highest interest rates among developed countries. Interest rates in Australia and New Zealand are higher, but their financial markets are not as advanced as in the UK.

As a result, many investors who already have positions or are interested in new carry trading positions have sold currencies such as the U.S. Dollar, Japanese Yen, and Swiss Francs and purchased GBP as relative currency.

Carry trading is to sell or borrow low-interest currencies to invest in high-interest currency assets or manage loans. In recent years, demand for pounds has increased as carry trade has become more common. However, if the interest rate difference between the pound and other currencies decreases, the liquidation of the carry trade will increase the volatility of the pound.

 

3. Difference in interest rates between British and foreign government bonds.

 

The difference in interest rates between UK & US government bonds (leading indicators of GBP/USD) and UK & German government bonds (leading indicators of EUR/GBP) are indicators that participants in the forex market consider.

This difference in interest rates can determine to what extent the premium of UK bonds is higher than or vice versa for US and European bonds. German bonds are used as barometers of European interest rates. These differences offer a signal of potential capital flows or currency movements for traders. Currently, the British currency has the same credit stability as the United States.

 

4. Euro-Pound futures provide a sign of interest rate movement.

 

It is vital to keep an eye on the potential changes in interest rates as UK interest rates or bank repo rates are used as a significant policy means for monetary policy. Government officials’ remarks are becoming a way to capture changes in interest rate trends. It is also releasing the vote results by members of the Monetary Policy Committee of the Bank of England.

Announcing the results of a committee member’s vote means that their opinions are not those of the Bank of England but personal. Therefore, it is necessary to look for other signals to predict potential changes in bank interest rates.

The three-month euro futures reflect market expectations for the next three months of the euro. These indicators help predict changes in UK interest rates and ultimately affect GBP/USD’s movement.

 

5. British politicians’ remarks about the euro affect the euro.

 

Comments on the euro (especially those made by the prime minister or finance minister) or opinion polls impact the foreign exchange market.  A fall in interest rates would lead to the liquidation of the position of carry traders. 

The British economy has now grown well under the supervision of monetary authorities. EMU is currently experiencing many challenges due to participating countries that do not meet the convergence criteria for EMU membership.

For the ECB, a single monetary authority, to govern (19 countries, including the UK), the EMU must create a monetary policy that can coordinate all the affected countries’ economic situation.

 

6. GBP has a positive link to energy prices.

 

Britain has the largest energy companies in the world. Energy production accounts for about 10% of the UK GDP, and as a result, the UK pound correlates with energy prices. Many EU countries import crude oil from the UK, so if oil prices rise, they will eventually have to buy more pounds to finance their energy purchases. Rising oil prices will also boost profits for British energy exporters.

 

7. GBP Cross Call

 

The GBP/USD currency pair tends to be more sensitive to the U.S. economy. However, both currencies are interdependent. This means that the movement of EUR/GBP can permeate the movement of GBP/USD, and vice versa.

The movement of GBP/USD can also affect EUR/GBP transactions. Thus, pound traders should consciously watch the trends of both pairs of currencies.

The EUR/GBP exchange rate should be the same as dividing EUR/USD by GBP/USD. Market participants often engage in arbitrage using slight differences between exchange rates, so these differences disappear very quickly.

 

 

Important Economic Indicators in the UK

 

 

The following economic indicators are all important indicators of the United Kingdom. However, since the UK is a service-oriented economy, it is better to focus on figures, especially the service sector.

 

1. Employment

 

England conducts the monthly survey. The survey aims to classify the workforce into three groups – employed, unemployed, and non-labour – and provide detailed data on them.

The survey data provide market participants with critical information about the labour market, such as the industry-specific employment movement and the unemployment rate of working hours.

 

2. Retail Price Index

 

The retail price index RPI is an indicator of the price movement of the consumer goods basket. The traders watch RPI or RPI-X except for mortgage interest payments. The Treasury Department uses the RPI-X for price targets. 

 

3. GDP

 

The quarterly report investigated by the Bureau of Statistics is the total value of all goods and services produced in the UK. GDP is calculated by adding net foreign purchases to household, business and government spending.

The GDP deflator is used to convert gross output measured at current prices to fixed-dollar GDP for the base year. High growth rates are often interpreted as inflation, and low (or negative) growth rates suggest economic recession or sluggish economic growth.

 

4. Industrial Production

 

 

Industrial production, IP Index, measures production changes in the UK’s manufacturing, mining, quarrying, electricity and water supply industries. Industrial production surveys the physical quantity of products, not sales, and multiplies the price to produce. Because IP accounts for one-quarter of GDP, we can understand the current economic situation.

 

5. Purchase Manager Index

 

The Purchasing Managers’ Index (PMI) is a monthly survey published by the British Purchaser Association, a weighted average of seasonal factors for production, new orders, inventory and employment items. Above 50 means the expansion of the competition, and below 50 means the contraction of the competition.

 

6. The Number of UK Housing Construction

 

The number of housing construction projects is a survey of the number of residential building projects constructing. The housing market is an important indicator because it is a significant industry that sustains economic growth.