Key Factor 4. Trade and Capital Flows
Before you make your final prediction about the trend of a country's currency, you should take a moment to categorize the country as dependent on either trade flow or capital flow. Trade flow refers to how much income a country earns through trade. Capital flow refers to how much investment a country attracts from abroad. Some countries are sensitive to trade flows, while others are far more dependent on capital flows.
Countries whose currency strength depends on their trade flows include:
- Canada
- Australia
- New Zealand
- Japan
- Germany
For countries such as the US and UK, which have large liquid investment markets, capital flows are of far greater importance. In these countries, financial services are paramount. In fact, in the US, financial services represented 40% of the total profits of the S&P 500.
The United States also serves as a perfect example of why it is crucial to understand which flows affect which country in order to effectively analyze the direction of currencies. On the surface, the US currency, with its record multi-billion dollar trade deficit and near $1 trillion current account deficit should depreciate significantly. However, that has not been the case. As the chart below illustrates, the US has been able to attract more than enough surplus capital from the rest of the world to offset the negative effects of its massive trade deficits.
The US has massive trade deficits. However, its currency remains strong because it consistently attracts large amounts of investment capital (capital flow).
For the time being, trade-flow deficits do not matter to the dollar. However, should the US become unable to attract enough capital flow to offset its deficits, the currency may weaken.
Understanding the influence of trade and capital flows has been important to a number of our trades, including our New Zealand dollar/United States dollar (NZD/USD) trade on January 22, 2007.
Uridashi Bond Prediction Returns 40 Pips
New Zealand has one of the highest interest rates in the developed world (as of January 2007 it was 7.25%), and because of that fact, it is a major destination for capital flow. On January 22, 2007, there was talk of Uridashi bonds being issued to the benefit of the NZD. Uridashi bonds are issued when companies want to denominate their debt in a higher yielding currency and then offer it to Japanese investors. These are popular because the yield offered is far higher than the yield that Japanese investors can earn at home, which is less than 1%.
We anticipated that the week’s Uridashi issuances would inspire capital flow into New Zealand as investors purchased the bonds in New Zealand dollars. Once we made this prediction, we had to decide which New Zealand currency pair we would trade to best take advantage of the movement of the New Zealand dollar. We considered both the NZD/USD pair and the NZD/JPY.
We decided to go long the New Zealand dollar against the US dollar instead of against the Japanese yen. The risk/reward ratio to go long NZD/JPY versus NZD/USD was not as attractive. Our stop in the NZD/USD was more conservative than the risk we would have assumed in NZD/JPY. Therefore, we went long NZD/USD and banked 40 points over the next 24 hours.
New Zealand dollar vs. United States dollar, January 22, 2007. We traded the New Zealand dollar / United States dollar on January 22. The trade returned 40 points in 24 hours.
New Zealand dollar vs. Japanese yen, January 22, 2007. The New Zealand Dollar / Japanese yen trade would have been a higher risk than the above-charted NZD/USD trade.
Five Key Factors that Move the Forex Markets..
..and How to Profit from Them!
1.Interest Rates 2.Economic Growth 3.Geo-Politics
4.Trade and Capital Flows 5.Mergers and Acquisitions
..and How to Profit from Them!
1.Interest Rates 2.Economic Growth 3.Geo-Politics
4.Trade and Capital Flows 5.Mergers and Acquisitions
