Today, we bring you an interview with Marc Chandler, the global head of currency strategy for Brown Brothers Harriman. Previously he was the chief currency strategist for HSBC Bank USA and Mellon Bank. Marc is a prolific writer and speaker whose essays have been published in the Financial Times, Barron’s, Euromoney, Corporate Finance, and Foreign Affairs. He is also the contributing economic editor for Active Trader Magazine and to TheStreet.Com. Below, he shares his thoughts on fundamental analysis versus technical analysis, the false Euro rally, Japanese Yen intervention, and other subjects.
Forex Blog: I would would like to begin by asking you to briefly explain your approach to analyzing the forex markets. Do you prefer technical or fundamental analysis, or a combination of both?
I’ve been analyzing currencies for a while, more than 20 years. I tend to think of myself as a fundamentalist, that is I look at macroeconomics, I look at policy, but at the same time, I’m a strategist, so I’m not just forecast GDP or trade. Ultimately, my goal is try to see where the currencies are going themselves, like the Euro or the Yen, or the Canadian Dollar. I find that technical analysis helps me quantify the risk at what level do I admit I’m wrong. And that’s very important. I think that often times, one would think that with economists, it’s always about being right. And I think that with trading and strategy, risk management is the most important thing. I find that technical analysis tells me where I should put my stop in effect – where I should admit that I’m wrong, unlike fundamentalists that say any level of US GDP or trade balance, the Dollar could be all over the place. Tehcnicals help me identify, help me fine-tune that a bit. I think that trading is so difficult that I need to use all of the possible tools that I have had at my disposal. It’s not just fundamental knowledge, but also studying psychology and price action.
Forex Blog: As head of currency research for Brown Brothers Harriman, it looks like you cover most of the major currencies, as well as a handful of emerging/exotic currencies. What do you think about the macroeconomic gulf that is forming between the “G4″ economies (US, UK, Eurozone, Japan) and the emerging market economies (along the lines of debt, GDP growth, etc.)? Do you think that this division is reflected in forex markets?
Most of my career, I’ve focused on the major currencies, but to tell you the truth, it’s kind of blurry what’s an emerging market, especially with all that’s come to light during this crisis. Mexico, for example, Israel and South Korea are OECD countries and yet MSCI and some of these other investment agencies might consider them emerging market, so the line is really blurry.
For example, recently, the Bank of Japan intervened and they bought a lot of US Dollars. But it’s not clear to me – because the Chinese currency is so closely tied to the US Dollar – it’s not clear to me that maybe Japan wasn’t just as concerned, or even more concerned with the Yen against the RMB – since China is its biggest trading partners – as with the Yen against the Dollar. But they had to intervene on Dollar/Yen because of the way the foreign exchange market works and because China’s currency is not convertible.
While I tend to focus on the major countries, I don't really know how to do the job and think about the world and global capital markets without recognizing and integrating what's going on in many of the major emerging markets.
Forex Blog: Do you develop your own macroeconomic forecasts or do you simply plug in the data that your economist colleagues have developed?
Brown Brothers doesn't really have a global economist- they're not that kind of bank. So when it comes to GDP, for example, I will not have a formal forecast for it. I will have a guess of it and I'll shy one way or the other from the broad market consensus. So for example, the broad market consensus for Q3 US GDP is about 1.9%. I would think of myself as a little bit above there. The important thing for the markets is instead of forecasting GDP as the end result, my end result is the Dollar or the Euro. And I would be looking at GDP, at relative economic strength as one of the inputs in an informal exchange rate model.
I would say that the emerging markets typically grow faster than the industrialized, mature economies. I find that faster emerging market growth – to me that's more like a "dog bites man" story. This crisis, unlike past crises, from 1995-2002, these were emerging market crises: East Asia, Latin America…this is among the first crises that originated in industrialized countries.
Many of the emerging market economies have strong domestic demand, so they were able to compensate for the weakness in foreign demand. But they've also benefited from the terms of trade: higher commodity prices than manufactured goods prices. I think in general, that many people look at the debt levels of advanced, industrialized countries and worry that the US is becoming Greece or Argentina. I think that kind of thinking is misguided. It confuses things. It confuses cyclical comparisons with structural developments. I think there's no doubt that the US is not Argentina. The Dollar is a major reserve currency. Most trade is invoiced in US Dollars – even when Australia sells iron ore to China, it's probably invoiced in US Dollars and paid in US Dollars – not Argentinian Pesos or Mexican Pesos or whatever the current threat to the US Dollar is.
Forex Blog: Based on this, then, you don't see any inherent contradiction between the Dollar's strength and the gap in growth fundamentals between the US and emerging markets?
Since the opening up of China, for example, in the late '70s, China has definitely grown faster than the US. I'd say that's also true form many Latin American countries like Brazil. Of course they grow much faster than the US, Europe, and Japan. But sometimes what determines currencies are not relative growth differentials. If you think about what's happened since Lehman's collapse, the Japanese Yen has been the strongest currency, and I don't think that's because of strong Japanese economic fundamentals. I think it has to do more with the unwinding of carry trades – Japan being a current account surplus country – that seems to be more telling than saying they have a booming economy, which of course they don't. There's no free lunches; the reason Brazil, Turkey, and South Africa offer higher interest rates is to compensate investors for some of the risk (political risk, inflation risk, maybe even historic risk – that you couldn't depend on these counties in the past, and the market has to anticipate issues going forward). For example, Brazil (Real) is one of peoples' favorite currencies, and the budget deficit is at an 8 month high, and they are approaching a current account deficit. So when I hear about fundamentals, it kind of begs the question, 'Well, which fundamentals should be reflected, and what happens if the fundamentals are pointing in contradictory directions?'
Forex Blog: Is there a particular (emerging) currency that you think is not getting enough attention?
I'm looking for an opportunity to buy the Brazilian Real, although I think it could weaken first. I also like India – I think they're the tortoise compared to the rabbit of China. I like Malaysia. I like Columbia. I like China. We generally think that in the emerging market space, Asian currencies over time, will appreciate against the US Dollar. They have favorable dynamics, pulled into the Chinese economic orbit, still tied to the US tech cycle, strong underlying economic fundamentals, and pressure to raise interest rates.
Forex Blog: On your financial blog, Marc to Market, a recent post was entitled, “The Yen Conundrum.” Can you elaborate on the contradiction between weak Japanese fundamentals and the strong Yen? Do you expect the trends in capital flows that are arguably behind the Yen’s appreciation will reverse anytime soon?
To me, the Yen's strength is kind of like a thermometer – a temperature check for a sick patient. I suspect that the Yen's strength is a function of the deleveraging taking place in the world. When the deleveraging stops, I will be more confident that the Yen has peaked. I'm not sure that is the case yet. I think intervention kind of caught some people by surprise. They spent a lot of money to get the kind of advance they got. They got 3-Yen advance – about a 5% move. The big picture is that it might lose some strength, but gradually.
Forex Blog: Speaking of the Yen, the Bank of Japan recently “intervened” on its behalf. Do you expect that this is only the beginning of a long program of intervention? Given the poor track record of the Swiss National Bank (in terms of the Franc), do you think that other Central Banks may follow suit?
This was a unilateral intervention. There are people who say that this opens up a Pandora's Box for other countries to intervene, but I don't think so. I think that those Central Banks that were inclined to intervene have already been intervening, like some Asian Central Banks and like Brazil. They continue to intervene. I think that it's unusual for a G7 country to intervene. I don't think that any other G7 country will intervene, though earlier this year and last year, though Switzerland did intervene quite actively and aggressively as part of their quantitative easing. With Japan, it does depend on the Yen/Dollar. However, the Japanese Yen intervention was quite large, and usually the first intervention is the biggest intervention. It's been a week now, and they haven't been in. Since that Thursday, the low that we've been at was 85.25 and we're just above there right now. But it does not appear that they are sterilizing intervention, though it's hard to tell because of the volatility caused by it being the end of the fiscal half year. Generally speaking, I think that the Japanese are not committing yet- they bought just short of 20 Trillion Yen – about $2 Billion – and I don't think that's enough yet to have really changed the general tide in Dollar/Yen. I think the deleveraging process has more ways to work and it's bigger than 20 Billion Dollars.
Forex Blog: When the Euro rallied in the beginning of the summer, a number of forex commentators (myself included) declared a paradigm shift, whereby investors would stop worrying about risk and instead focus on the fundamentals. Ultimately, this shift never materialized, and the Euro appears to have resumed its decline. What is your assessment of the Euro’s recent performance, and what can we expect for the immediate future?
I think that the Euro's bounce over the summer was a function of people taking a step back from the abyss. In the spring, it maybe looked like the Eurozone would collapse and members would drop out. When people realized that the Euro would survive and institutions would be reformed, the Euro bounced back a bit.
I think that we're kind of caught now between problems in Europe – I think that risk assessment is fundamental. I do think that most recently, the widening of the spreads in Europe has not read to new Euro weakness, that being said, it might be preventing a serious Euro rally. We're still about 2 cents below where we were in August. On the other hand, the Dollar has stood on 2 legs. One is bad things in Rest of World (ROW) and the other is good things here. But those good things have faded, and quite quickly in Q2. And so my equilibrium level for the Euro if there is such a thing is probably a bit higher than at the beginning of the year, about 1.33 – 1.35 to the Dollar.
You also have to look at restructuring of Euro debt, and ask, 'How did Greece live beyond its means.' The answer is that they were buying lots of goods and German Banks were happily lending them the money to do so. In fact, 70% of Greek debt is owned by non-residents. Going forward, the problems can only be overcome by stronger growth, which doesn't seem likely at the moment. Still, assuming that interest rate differentials (between Germany and the rest of the EU) narrow, we will see the Euro strengthen.
Forex Blog: I recall a Bloomberg News video segmentin which you highlighted the 200-day moving average as an important forex indicator, especially for investors with a long-term outlook. Could you explain this for the benefit of my readers? Are there any other basic technical analysis indicators that you think fundamental analysts should pay attention to?
First I just want to say that we must appreciate time frame. For example, most fund managers have a medium time frame, and it doesn't make sense for them to look at daily bar charts. That's really just false symbolism, noise.
I like the 200 day Moving Average because it gives you a sense of trend. I think I remember the Bloomberg story that you're referring to. I was looking at 250 day Moving Averages, and the idea of what some people call Golden Crosses. The idea is that the 50-day Moving Average has gone below the 250 Day Moving Average, in the Swiss Franc and the Pound. If you look at the Euro/Dollar exchange rate, the last time this happened was when the Euro was launched in 1999, and it led to a large sell-off. As I aid though, you have to ultimately look at time frame.
Forex Blog: I haven’t read your book, but I’m intrigued by the title: “Making Sense of the Dollar: Exposing Dangerous Myths about Trade and Foreign Exchange.” Are there any particular foreign exchange myths that are especially pertinent and that you’d like to share?
The thesis of my book is that US Dollar expansion strategy is more robust than friends and enemies insist. For example, I look at the current account deficit. People say it makes us poorer but I show that's not really the case. People think that companies service foreign demand through exporting, but they should be looking at sales from US affiliates, which have been 4 times as much as exports. In other words, build locally sell locally.
Forex Blog: What is your advice for (forex) investors that want to beat the market during these uncertain times?
Well I think that forex investor is an oxymoron, but anyway, there is a misconception that traders win by being right more than they are wrong. I think you win through discipline. That means honoring your stops and limiting your losses. Entry and exit levels are less important than discipline.
I started looking at currencies around the time the Plaza Accord was signed, and since then, I can't remember ever seeing certainty in the currency markets. You can make a case for bonds and stocks being connected with the business cycle, but the forex connection is more elastic, more variable. I think that this is an advantage for currency traders because it means they are accustomed to uncertainty.
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