Currency Traders: The Fed Has No Clothes! Part 4

04/24/2008 12:00 am EST

Focus:

Timothy Morge

President, MarketGeometry.com

(Or, in other words: What’s Going To Happen With the US Dollar?)

For the next three years, the central banks intervened aggressively in the currency markets, and they made it a habit to try to get the most ‘bang for their buck’ by confirming their intervention and usually leaking their intent to intervene before the markets even opened to a select few traders. And so it seemed to many traders that the central banks ‘called the shots’ and had complete control over this market. And when traders today talk about those three years and talk about the Fed and the other major central banks in general, they seem to feel they are fairly invincible when they want to take action. But nothing could be further from the truth.

Like all things in life, if you use a trick too often for too long a period of time, people get used to it and it begins to lose its effectiveness. The dollar had fallen so far, traders that tried to sell as soon as they heard the central banks were intervening usually found themselves short US dollars at poor levels, because they had jumped in and sold the break out to new lows. After several years of seeing the same announcements and watching the central banks pummel the markets, traders simply got smart: when the central banks intervened, they simply stepped out of the way.

Once the general market stopped jumping on the bandwagon when the central banks announced they were intervening, the traders the central bankers were using also quit initiating their own new short positions—instead, when the phone rang and they got the order to sell dollars, they’d simply execute the order and then go back to what they were doing. This indifference to the central bank sell orders quickly highlighted the truth: without a trend, the central banks were just market participants. The size of the cash FX market is so large, no one player or even five or six players—even five or six or seven central banks—can turn a major trend around in the cash FX market. The trends in the cash FX markets come from huge capital flows and only long-term changes in the policies that cause these flows eventually stop and turn the trend.

When traders these days think about that three year period, they believe the Fed and the other central banks changed the trend in the dollar and sent it reeling lower; time gave the central banks ‘super hero powers’ they never had in real life. The dollar had been falling for more than six months and had declined more than twenty-five percent from its highs before the central banks even started to plot the Plaza Accord in 1985.

When they finally acted, they jumped on a fast moving train: The dollar was already in a very strong down trend and they simply advertised their blessing of the existing trend. Here’s a chart that shows where the US dollar peaked and just how far it had fallen before they began to blatantly sell dollars:

More in part 5…

By Timothy Morge
tmorge@sbcglobal.net
www.marketgeometry.com
www.medianline.com

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