The eagerly-awaited Obama and Bernanke speeches supported equity markets this past week but turned out to be very much non-events. Attention of traders will remain on the next FOMC meeting on the 21st September.

Meanwhile, European problems still loom and the Greek debt rollover should come to some kind of conclusion Friday, or over the weekend at the latest. We also have the G7 meeting as a possible risk event over the weekend but this should turn out to be nothing more than a useless jawboning exercise.

On the bright side, the Citigroup Economic Surprise Index keeps recovering and the dividend yield on the S&P 500 is again below the 10 year treasury yield:

Citigroup US Economic Surprise Index – source: Bloomberg

The combination of these figures and expectations of “QE3-like” action from the Fed should keep providing relative support to US markets. But this remains pretty meager when put against the European situation.

Indeed, as long as there is no structural solution to the European sovereign/banks problems, we are left exposed to a major shock in Europe which of course would reverberate across global markets. We still see European banks, especially French names, heavily under pressure despite this past week’s rebound and continued pressure in the European bonds and money markets spaces.

The pressures in the bond markets are best illustrated by the spread of the Italian bonds over German bunds:

Spreads of BTPs over Bunds – source: Bloomberg

For the money markets, a look at the 3-month Euro basis swap shows the continued tensions in the USD funding market for European banks. And we heard this week, interbank funding markets in Europe are pretty much frozen…

Euro basis Swap 3 months – source Bloomberg

So, yes, most commentators are bearish, which is usually a sign that it is time to turn, but is the problem not a political issue in a Eurozone which lacks leadership and political courage? We believe that structural decisions will only be taken in Europe in an extreme emergency situation and this still needs to happen…

Looking at the technical picture, here the trends we have been looking at over the recent past. For DAX, the trend remains negative and this is justified by the fundamental issues touched upon above.

DAX cash index – 30 minutes chart – source: Bloomberg

Clearly, 5,500 is a big line in the sand (green line). What we refer to as the congestion area is where most of the volume has been traded in the futures market over the period. Hence this would come as a potent resistance area on the way up. Much good news (and we are left blank on the subject) would be needed to break this downtrend.

On the downside, there is not much else than hope in the way of the round 5,000 number so the path of least resistance remains to the downside. For the coming week, we will therefore watch how the German benchmark behaves around the 5,500 (should it come back there).

Just to give a bit more color to the overall trend, we reproduce the monthly chart for the DAX with the 12 months moving average as well as a standard MACD indicator. As we showed in a previous post, the standard MACD has proven to be a good long term rend indicator over the past 11 years:

DAX cash index – Monthly chart – source: Bloomberg

For the S&P 500, we show the points of reference we have used over the period:

S&P 500 September futures contract – 30-minutes chart – source: Bloomberg

The US benchmark has a bit more stickiness to the upside essentially due to the “Bernanke Put” and the fact that the US is one step ahead of Europe in coming out of the current mess.

In any case, the index is still trading in a congestion zone 1,205-1,175 and should find some support there but keep in mind that the 1,150-level is becoming more and more important as a support in the current uptrend for next week.

A break of this support should find us quickly testing the 1,130-20 support where the market may think that the Bernanke rescue team is sharpening their pencils once again…

For the upside scenario, we need to see the index hold 1,200 to make an attempt higher but we would use the strength to get back on the short side in the 1,220-1,250 area.

Overall, going into a volatile week, it may again be wise to look for a continued divergence in performance between Europe (DAX still being the only major index to be available for shorting in Europe) and the US (via the S&P 500).

source from: tradingfloor

The competition between banks ensures tight spreads and fair pricing. For individual investors, this is the source of price quotes and is where forex brokers offset their positions. Most individuals are unable to access the pricing available on the interbank market because the customers at the interbank desks tend to include the largest mutual and hedge funds in the world as well as large multinational corporations who have millions (if not billions) of dollars. Despite this, it is important for individual investors to understand how the interbank market works because it is one the best ways to understand how retail spreads are priced, and to decide whether you are getting fair pricing from your broker. Read on to find out how this market works and how its inner workings can affect your investments.

Who makes the prices?
Trading in a decentralized market has its advantages and disadvantages. In a centralized market, you have the benefit of seeing volume in the market as a whole but at the same time, prices can easily be skewed to accommodate the interests of the specialist and not the trader. The international nature of the interbank market can make it difficult to regulate, however, with such important players in the market, self-regulation is sometimes even more effective than government regulations. For the individual investor, a forex broker must be registered with the Commodity Futures Trading Commission as a futures commission merchant and be a member of the National Futures Association (NFA). The CFTC regulates the broker and ensures that he or she meets strict financial standards. (For more insight on determining whether you’re getting a fair price from your broker, read Is Your Forex Broker A Scam? and Price Shading In The Forex Markets.)

Most of the total forex volume is transacted through about 10 banks. These banks are the brand names that we all know well, including Deutsche Bank (NYSE:DB), UBS (NYSE:UBS), Citigroup (NYSE:C) and HSBC (NYSE:HBC). Each bank is structured differently but most banks will have a separate group known as the Foreign Exchange Sales and Trading Department. This group is responsible for making prices for the bank’s clients and for offsetting that risk with other banks. Within the foreign exchange group, there is a sales and a trading desk. The sales desk is generally responsible for taking the orders from the client, getting a quote from the spot trader and relaying the quote to the client to see if they want to deal on it. This three-step process is quite common because even though online foreign exchange trading is available, many of the large clients who deal anywhere from $10 million to $100 million at a time (cash on cash), believe that they can get better pricing dealing over the phone than over the trading platform. This is because most platforms offered by banks will have a trading size limit because the dealer wants to make sure that it is able to offset the risk.

On a foreign exchange spot trading desk, there are generally one or two market makers responsible for each currency pair. That is, for the EUR/USD, there is only one primary dealer that will give quotes on the currency. He or she may have a secondary dealer that gives quotes on a smaller transaction size. This setup is mostly true for the four majors where the dealers see a lot of activity. For the commodity currencies, there may be one dealer responsible for all three commodity currencies or, depending upon how much volume the bank sees, there may be two dealers.

This is important because the bank wants to make sure that each dealer knows its currency well and understands the behavior of the other players in the market. Usually, the Australian dollar dealer is also responsible for the New Zealand dollar and there is often a separate dealer making quotes for the Canadian dollar. There usually isn’t a “crosses” dealer – the primary dealer responsible for the more liquid currency will make the quote. For example, the Japanese yen trader will make quotes on all yen crosses. Finally, there is one additional dealer that is responsible for the exotic currencies such as the Mexican peso and the South African rand. This setup is usually mimicked across three trading centers – London, New York and Tokyo. Each center passes the client orders and positions to another trading center at the end of the day to ensure that client orders are watched 24 hours a day. (To continue reading about currency crosses, see Make The Currency Cross Your Boss and Identifying Trending & Range-Bound Currencies.)

How do banks determine the price?
Bank dealers will determine their prices based upon a variety of factors including, the current market rate, how much volume is available at the current price level, their views on where the currency pair is headed and their inventory positions. If they think that the euro is headed higher, they may be willing to offer a more competitive rate for clients who want to sell euros because they believe that once they are given the euros, they can hold onto them for a few pips and offset at a better price. On the flip side, if they think that the euro is headed lower and the client is giving them euros, they may offer a lower price because they are not sure if they can sell the euro back to the market at the same level at which it was given to them. This is something that is unique to market makers that do not offer a fixed spread.

How does a bank offset risk?
Similar to the way we see prices on an electronic forex broker’s platform, there are two primary platforms that interbank traders use: one is offered by Reuters Dealing and the other is offered by the Electronic Brokerage Service (EBS). The interbank market is a credit-approved system in which banks trade based solely on the credit relationships they have established with one another. All of the banks can see the best market rates currently available; however, each bank must have a specific credit relationship with another bank in order to trade at the rates being offered. The bigger the banks, the more credit relationships they can have and the better pricing they will be able access. The same is true for clients such as retail forex brokers. The larger the retail forex broker in terms of capital available, the more favorable pricing it can get from the interbank market. If a client or even a bank is small, it is restricted to dealing with only a select number of larger banks and tends to get less favorable pricing.

Both the EBS and Reuters Dealing systems offer trading in the major currency pairs, but certain currency pairs are more liquid and are traded more frequently over either EBS or Reuters Dealing. These two companies are continually trying to capture each other’s market shares, but as a guide, the following is the breakdown where each currency pair is primarily traded:

Cross currency pairs are generally not quoted on either platform, but are calculated based on the rates of the major currency pairs and then offset through the legs. For example, if an interbank trader had a client who wanted to go long EUR/CAD, the trader would most likely buy EUR/USD over the EBS system and buy USD/CAD over the Reuters platform. The trader then would multiply these rates and provide the client with the respective EUR/CAD rate. The two-currency-pair transaction is the reason why the spread for currency crosses, such as the EUR/CAD, tends to be wider than the spread for the EUR/USD.

The minimum transaction size of each unit that can be dealt on either platform tends to one million of the base currency. The average one-ticket transaction size tends to five million of the base currency. This is why individual investors can’t access the interbank market – what would be an extremely large trading amount (remember this is unleveraged) is the bare minimum quote that banks are willing to give – and this is only for clients that trade between $10 million and $100 million and just need to clear up some loose change on their books. (To learn more, see Wading Into The Currency Market.)

Conclusion
Individual clients then rely on online market makers for pricing. The forex brokers use their own capital to gain credit with the banks that trade on the interbank market. The more well capitalized the market makers, the more credit relationships they can establish and the more competitive pricing they can access for themselves as well as their clients. This also means that when markets are volatile, the banks are more obligated to give their good clients continuously competitive pricing. Therefore, if a forex retail broker is not well capitalized, how they can access more competitive pricing than a well capitalized market maker remains questionable. The structure of the market makes it extremely difficult for this to be the case. As a result, it is extremely important for individual investors to do extensive due diligence on the forex broker with which they choose to trade.

source: investopedia

Brazil, South Korea and Indonesia have unveiled this past week various measures and forms of capital control to help better manage foreign exchange risks and imbalances. These measures are seen as attempts to limit their respective currencies’ appreciation versus the Dollar.

As the U.S is the world’s largest importing economy and China is the world’s largest exporting economy the continuous weakness in these currencies is hurting exporters in competing countries. The exporters suffer both from erosion in profits as well as extreme competition from China which hinders global economic recovery.

This concern over the strength of local currencies aided the USD during Thursday’s trading and if the restrictive stance is set to continue, these one sided interferences with the exchange rate might provide a much needed boost to the Dollar.

source:  forexyard.com