MAGGIE LAKE: Are investors paying enough attention to the forex markets? Hi, everyone. Welcome to the Real Vision Daily Briefing. Weston Nakamura, our global markets editor, is here with us today, and he is adamant that we are definitely not paying attention, enough attention to currency markets. Hi, Weston.
WESTON NAKAMURA: Hi, Maggie. And I wouldn't necessarily accuse or say that, but I am saying that we should probably be paying more attention than we are.
MAGGIE LAKE: Okay. Well, that's fair enough for the clarification. But it is something that we were really chewing over when we were having an internal conversation because listen, for those of us rolling in here in the US, rolling in after a long holiday weekend, it was hard to know what to pay attention to.
We had a stronger than expected services ISM. We have a new PM in the UK. We have European energy companies and that situation just getting worse by the moment. The yen making monster moves. It was a lot to walk into. And I want to talk about all of it. But I think that you were making some really good points to us about the importance of looking at currency markets, so let's bring that conversation to the outside world. Why is forex a place that you watch so closely right now?
WESTON NAKAMURA: Sure. Let me just preface this by saying I am not a traditional forex trader or have a forex background. I don't have any bias or by any means. I started off my career in institutional finance on the futures desk, which oversees basically everything, including forex, so I'm very apolitical in terms of asset classes to watch. The reason I watch--
MAGGIE LAKE: The cross asset Swiss Army Knife is what we like to call you.
WESTON NAKAMURA: Yes.
MAGGIE LAKE: Looks at everything.
WESTON NAKAMURA: Yeah, looks at everything, master of nothing basically. Basically, though, the reason I'm looking at it is because it's relevant to broader cross asset global market price action. Currently, at the moment, the FX markets have not just a better read on what's happening in asset markets, x forex, but also it's more of, I don't want to say more pure, but a less dirty read compared to the other asset classes, equities, rates, bonds or fixed income, commodities, almost the majors, on what's going on in the world at large and how markets are taking everything in. That's why I'm watching it.
MAGGIE LAKE: And that's really interesting and important, because let's face it, a lot of us have stocks in our retirement accounts, that tends to be what we look at. If you turn on the news on any given day, you're going to see, oh, the Dow was up, the Dow was down, the stock market did this. The general media does not really cover foreign exchange very much or very well.
If it's something that is giving signals that are worth paying attention to, not watching it, it's something we need to understand. So less polluted view of what's going on, talked about the services ISM.
WESTON NAKAMURA: Can I give you a polluted view first?
MAGGIE LAKE: And just so everyone, in case you missed it, the services ISM came in stronger than expected, which immediately led people to believe, okay, we're in for higher rates. That means the economy's strong and that it's not rolling over maybe and the Fed is going to have to keep hiking rates, there's going to be higher interest rates.
WESTON NAKAMURA: All right, so Brian, chart one, please. This is simply the SPX e-minis chart intraday from today, from earlier today. And you could see this looks like a flash crash almost. But basically what happened was at cash open, S&P index sold off down about 1.25%, then the better-than-expected services PMI came out, and then you see a massive V-shaped bottom reversal and a rally of back to flat more or less. And then you see this stair-step sloppy price action downwards.
Now, that purple shaded area, first of all, let's ignore the casual part, that surge upwards on the ISM print, that moment. First of all, that is not like human beings. Those are systematic flows, they are basically it headlines scanning algos and all that and they have futures locked and loaded and ready to just blast directionally. There aren't people that are intaking the ISM services PMI print, like digesting it, making it a directional investment decision and then executing that trade within a half a second. People are not involved in that.
So what does the equity market reaction tell me about how market participants writ large feel about the stronger than expected services PMI and therefore, what that implication is on the Fed and FOMC policy? Nothing really. For me personally, I don't really get any reading out of that.
MAGGIE LAKE: And that's important because I think a lot of us were-- because I came in and I was confused, because I was thinking, well hang on a second, if the Fed's going to keep raising rates, why would stocks be rallying? And you're right, a computer isn't making the nuanced is good news actually bad news now, or they're not doing that stepped out analysis and that's what you're getting-- if they scan the headlines, and they see a positive, well, that might be positive in another scenario, but is it that now? And so it is very sloppy, that response.
WESTON NAKAMURA: But even you can say that so then introduced the active fund manager, the human being. There's a whole disparate array of opinions about is good news bad news, good news bad news, bad news good news. I'm not trying to pick on the systematic flows only and saying that they're wrong, I'm saying that everyone's more or less probably got wrong, or at least is trading on uncertainty if they're even trading at all. The equity markets, especially during very illiquid summer days, doesn't really give me any signal or tell me anything as to what the sentiment is, or the actions are with regards to this specific print but like anything.
I'm just using this from earlier today. Equities, that doesn't really do it for me. The rates market, okay, so let's take the fixed income market, that does a better job. Raoul always talk about bonds are the truth--
MAGGIE LAKE: Chart of truth, yeah.
WESTON NAKAMURA: The chart of truth and all that. And while I agree relative to equities, bonds are still and fixed income and US Treasuries, and sovereign rates, and all that, and thereby, credit and fixed income writ large, but bonds are still very much under the heavy hand of central banks. Even if you have the Fed who is supposedly tapering, and they're running off their balance sheet, that is still very much a direct market impact.
The only way that you don't have a non-economic major actor with their fingerprints in these markets themselves is if they're absolutely gone and absent, that's post tapering. And even then, you're still going to-- if the perception by market participants is that the central banks and the authorities, top-down authorities can and will step in or are active in markets, if that's what they believe, then that in and of itself can become a self-fulfilling reality. And that will distort market behavior as well.
Rates markets are also not really that clean of a read of what's going on and how markets are digesting a piece of information, a piece of data, an event, geopolitical event, or what have you. Commodities markets, commodities as an asset class is probably the stupidest of all groupings, because that includes anything from gold to frozen orange juice concentrate to cotton to coal futures, and so on and so forth. Commodities is a very stupid overly broad thing.
But let's take something like oil, for example, because crude oil is supposed to be a barometer of certain extent of growth and inflation. But then we start getting stories like you and I were talking about before about margin on one and a half trillion outstanding notional in listed derivatives, and then you just have-- I was talking about this video that I put out about everything in futures markets correlating regardless of what the underlying is, be it cotton futures, yen futures, Treasury futures, gold futures, WTI crude futures.
On March 7th, like prior to March 7, they have a blow off top, then on March 7th of this year, they all just plummet down. Just one giant margin call, regardless of what the underlier is. That doesn't really tell me anything either, these markets either so what's left is the FX markets. What keeps the FX markets honest, if you will, is that it's a market that has a built-in checks and balance system, if you will.
You can't just buy just the yen, or just the British pound or sell just the Aussie dollar. It's a pair trade, so there's always another side to it. If the Japanese authorities for example, if they want to intervene or if they want to manipulate the yen, or whatever it is, you can't just do that by yourself, there's still the EUR part of it or the USD part of it. There's still Secretary Yellen involved or Christine Lagarde involved with this.
So FX markets keep each other in check because of the nature of the fact that they are pair trades against one another and they are a big trade, almost 24, not 24/7, 24/5, and they are just, relatively speaking, more of a cleaner read of what markets are-- how they feel about some particular datapoint or an event.
MAGGIE LAKE: Yeah, it makes an awful lot of sense when you lay it out like that. It really does. So if we're looking at the forex markets, what are the messages that you're getting? What are you watching?
WESTON NAKAMURA: Sure. Let's just take, because you mentioned UK has a new prime minister, Liz Truss, so Brian if you pull Chart 2, please. All night, all day for you, I've been watching the yen get destroyed, dollar/yen just moving higher and higher. The new prime minister, Liz Truss, she made her speech outside 10 Downing Street around, actually, I don't know what time it is in New York or London--
MAGGIE LAKE: It's understandable that you don't know the time zone. This is what happens when you never sleep.
WESTON NAKAMURA: So what happened though, was that dollar/yen, which was surging towards breaking into the 143-handle, or a new big figure on the day, just took a pause at that moment. And that was because of the British pound against the yen, which the British pound, Brian, pull up Chart 3, the pound has been getting destroyed over the last month or so, several weeks, just pretty much one-directionally even with a very hawkish BOE, however, the pound has not really been getting destroyed against the yen, the yen has been getting destroyed more on relative basis.
And so GBP/JPY and USD/JPY going into today were actually performing quite well. And then you start seeing profit taking on GBP/JPY. What my point about the pound and how it relates to dollar/yen or dollar assets or the other cross-currency pairs is that something like the British pound and a UK leadership change, that, I guess would fundamentally have nothing to really do with the yen, per se, even though these are G5 leaders and of course, they are very much interlocked and all that.
But they can still impact other cross-currency pairs, let alone other asset classes, in and of themselves. And so you really do need to look at, not just FX, but you need to look at specific currency pairs, and how they relate to whatever event or whatever region, not just the broad dollar.
MAGGIE LAKE: So that's the thing, and I'm sure if I scan down the questions, we're going to have that-- because you could look at something like the ISM and say, oh, of course, that's going to mean stronger dollar. And then we get questions all the time about the DXY, or something, but you don't look at that. We need to drill down past that. Why not? Why not look at that broad measure?
WESTON NAKAMURA: Yeah, Maggie, that's my peeve, the DXY, the dollar spot index.
MAGGIE LAKE: I did not know this, but now we do. Why?
WESTON NAKAMURA: Yeah. The DXY, I think, is doing a major disservice to market participants. Because what it does is broadly speaking, and philosophically speaking, if you will, it makes the dollar a standalone asset, if you will. And like I said, currencies are-- you cannot just buy just one currency, it's a pair trade, you're shorting something else, you're selling something else to buy the dollar. But the DXY removes that mentality.
And so people talk about the dollar. But whenever someone talks about the dollar, I'm always asking like, the dollar against what? Legitimately. I don't know. And I need to know what you're talking about, the dollar against what? Are you talking about against the Euro, the yen, the British pound? Are you talking about some obscure emerging market currency? Are you talking about the Turkish Lira, whatever it is?
And what DXY, the reason that I think it just has way too much importance put on it, I'm not saying it's not important, but the reason it has a weak too much importance put on it is because I don't believe that it reflects a very nice balanced basket of global currencies. It's 60%, two-thirds of it is the Euro. And that's fine if it was designed that way, but it wasn't. The DXY index was constructed pre the Euro becoming the single currency this Eurozone. It was split up into the German Deutsche Mark and so on so and so forth, the Italian crazy.
And they all had equal weightings in like the low teen digits or whatever they are, but then they all just merge into one gigantic currency block and now you have one that's the Euro. All you say is it's almost like the S&P 500, which as we know, is an index that's weighted very heavily towards the top five or so tech stocks, the Apple, Amazon, Tesla and Google, so on, so forth, Facebook Meta, whatever.
It would be like if, let's say those companies' combined, had a super illegal merger called Monopoly Corp. And let's say Monopoly Corp. was one stock, and that was 60% of the S&P 500 weighting. And then the other 499 names were the remaining 40% The SPX would not be a good broad-based reflection of corporate America, publicly traded corporate America by any means. It's just Monopoly Corp. mostly. That's how I look at the DXY, and the Euro dominance.
MAGGIE LAKE: I'm guilty as charge because I will ask people what are your thoughts about the dollar? Like, do you think the US dollar is going to remain strong? And I'm not saying against which pair, so I fall into that myself. But you're right, like how do we know relative. So if we bring this back, I just want to wrap on the pound because we noticed a chart of the day from our friend Jim Bianco put out, Jim Bianco Research put out and it was US dollar, the cable pair, which is what that's called, the US dollar versus the British Pound.
And he was talking about chart of the day that just shows you the decline of the pound. But when you're looking at the crosses and what you were talking about with the yen, is that an indication that investors are nervous about the UK situation, and that's the only reason the yen stopped, because they felt more unsettled about the pound than they did the yen? What do you pull out of that, those crosses that you were talking about?
WESTON NAKAMURA: Sure. The yen, and how it relates to the British pound, for something as monumental as leadership change that happened last night and into today, and a ton of uncertainty left, the GBP/USD cross is not really moving that much, or something really big. And obviously, there's a lot of assumptions that Liz Truss would take and even if it was [?] back then, there's not really that much of a difference. But what I'm taking from it is that that lack of movement from GBP/USD or GBP/EUR is that Liz Truss hasn't actually said anything or done anything yet so there's information in lack of movement in currencies as well.
People are still holding their breath. I think that she's going to be rolling out her cabinet soon and hopefully just spell some more concrete steps as to what to do. She's in a very, very difficult spot that she's inheriting right now in the UK with inflation, with energy, and all that, with a falling currency, with workers, riots or strikes and so on, so forth. She's just entering a very difficult spot and the lack of movement in the pound versus the dollar is telling me that not that things aren't fine and sanguine, it's that people are still waiting and you'll probably see some directional movement in either direction.
You'll probably see the pound or the Sterling to strengthen against the dollar after it's been sold down this much. Just not anything, just because it's some certainty because uncertainty is the biggest enemy of markets. It's worse than bad news because bad news is therefore priced in and you know what to do. But as it relates to the yen, when I see the GBP/JPY going down while GBP/USD and GBP/EUR basically just staying flat, that's telling me that the yen is getting sold specifically.
Brian, if you go to Chart 4, this is intraday, this is today, a full trading day of the yen. And I've broken this chart up into three color regimes, and what that is basically-- the chart in and of itself is those are yen futures in green and the yen futures volume on the bottom, you could see the corresponding moves and all that. And then I've overlaid in the blue shaded area just spot dollar/yen for reference.
The spot dollar/yen rate is being moved by and large by these listed derivatives, by futures and options on these futures. And I've split them up into these three separate color regimes and what those are are FX trades, pretty much day like round the clock all day. But it has like three more or less trading sessions, if you will, and trading hubs globally. The first one to start the day is Tokyo. And then in comes UK, London, which is really Europe, but it's really London at the center of it, and then the US overlap.
And what you could see here is that to start the day, at least in the a.m. in Japan, domestics were buyers of the yen. But then as you get towards cash close, and towards that flipboard, the London traders come in, that's when yen futures really started getting slammed down. And then they really got slammed down going into the US session and then throughout the US session. That's telling me that foreigners are sellers of yen or shorting the yen, whereas domestics are not. That could be domestics repatriation, that's the buy flows.
But what that's also telling me is that this is once again, the policy divergence trade. This is the hawkish Fed versus a dovish BOJ policy divergence happening and therefore, the yen gets shorted because the currency