You Don’t Sell Fazoola, You Buy It

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Talking about China fear and US ebullience.

by Brent Donnelly

August 15, 2023

https://www.nathanwpyle.art/

Current Views

Long AUDUSD @ 0.6480

Stop loss 0.6389

Take profit 0.6674

August 15, 2023

Extreme Fazoola Bears

When I was in university, Citibank brought a very sophisticated FX trading simulation game to my school. It was called “The Bourse Game” and it involved a full weekend of simulated trading. They had dedicated phone boards, simulated headlines, and streaming prices on glowing computer screens like the one below. It was awesome and confirmed to me at the time:

When I grow up, I want to be a trader.

At the start of the game, each team of two players was assigned a separate room and given some basic information about four countries and four currencies. There was a very strong economy called “Kikwanaland” and a very weak one called “Fazoola”. And two in the middle. And you received a packet which outlined the recent economic data and a bunch of recent realistic-sounding headlines from Kikwanaland and Fazoola.

Editor’s note: I know I told this story once before, in 2018, but it popped into my head today and it’s relevant. I’ll explain why after.

You were also provided a chart of the Kikwanaland rupee which had done well and a chart of the Fazoola pound which had not. Naturally, because we had no trading experience and we were 20 years old, most students wanted to buy the rupee because the narrative was so good, and they wanted to sell the Fazoolian pound. But it was a trick. The rupee was not the currency to buy because all the good news was priced in and so in fact, to have the best odds of winning the game you needed to go short the rupee and long Fazoolian pounds at the outset.

My teammate and I sensed the Kikwanaland story was too good to be true and so right on the open we went nuts buying Fazoola and selling Kikwanaland. Most of the other students were confused. “Wait!” they said to each other. “Why are they going short Kikwanaland?! Their economy is all that and a bag of chips!¹”

Needless to say, we crushed it P&L-wise. But sadly, we finished second because “you kept losing track of our position” and “your P&L tracking was not accurate”. We were docked points for bad accounting! Geez. I was very disappointed.

Fortunately, I ended up with one of the hot trading jobs at Citibank and my buddy scored a highly-coveted job trading natgas at Enron. I am not kidding.

Anyway, I bring this up because it reminds me of the US and China right now. USA is Kikwanaland. China is Fazoola. Today’s price action is another little piece of evidence that suggest to me that the USD just doesn’t really want to go up very badly and there is a strong asymmetry for it to go down from here.

We have spent all year buying AUD at 0.68 and selling it at 0.65 and at this point it seems more reasonable to plug your nose and say “it’s all priced in” than it does to go long USD or short AUD on higher US yields. The Fed looks like they’re done, leadership is endorsing rate cuts in H1 2024 and China is back to Q4 2021 “Evergrande is Lehman Brothers!” levels of bearish economic sentiment.

You might remember that the Evergrande crisis was a great time to buy AUD.

AUDUSD with the two big Evergrande moments marked

I’m going with a bit of gut feel here as the fever around China feels peaky to me as AUDUSD is right on major support and copper continues to hold the bottom of the range.

AUDUSD on strong support

Below you can see that copper is holding in OK, too, relative to the angst around China.

Copper well above the May lows and holding trendline support so far

If my idea is correct, it should work almost right away. Long AUDUSD here (0.6480) with a stop at 0.6389 and take profit at 0.6674. The bad news in China is priced in and commodity prices remain fairly-well supported. I am open to the possibility that we are entering a liquidity scare. If we are, I will get stopped out.

—

¹ Yes, that was a real expression that nerds used. Cool people would call stuff “the shiznit.” As in, “Insane in the Brain is the shiznit, man. Love me some Cypress Hill.

Final Thoughts

Peak China fear, September 2021.

https://www.bloomberg.com/news/features/2021-09-22/china-s-evergrande-debt-crisis-is-stress-test-no-one-wanted

Have a funny day.

good luck ⇅ be nimble

The Spectra FX Positioning and Momentum Report

Not much appetite for long USD (yet)

Hi. Welcome to this week’s report. FX volumes have been about 25% below average over the past week as the market quickly looked through US CPI and still obstinately refuses to embrace the dollar rally via USD longs. While upward USD momentum has been meaningful again in the last week, positioning has barely budged.

***

Observation One

A standard feature of momentum and positioning measures is that they normally together, somewhat in synch. If the USD goes up, USD long positioning will tend to increase (or USD shorts will get smaller).

The scatter plot here shows the change in our positioning metric vs. the change in US dollar momentum in 2023. As per the theory, a higher USD attracts more long USD positions (or triggers a reduction in USD shorts).

In the next chart, you can see that this week’s continued USD upside momentum (gray bars) has not led to as much of a change in USD positioning (blue bars), perhaps because USD shorts are now out.

Momentum forces USD shorts to cover, but the desire to go long USD is limited to fast money, and a few specific pairs. The market is happy to go long USDCNH and USDJPY but is unwilling to get aggressively long USD vs. the rest of G10. This is consistent with our client conversations as the end of the Fed cycle and exploding US deficits keep medium-term investors out of the long USD trade. Long USD is viewed as a rental, whereas short USD is viewed as a more acceptable medium-term view.

Change in USD momentum vs. change in USD positioning, weekly data for 2023

This could be seen as a reason for USD bulls to stay long, because eventually real money players will be forced to jump into the pool if US yields continue to rise and the US economy proves its resilience for the grillionth time. On the other hand, real money’s reticence to own dollars shows that if calls for rate cuts in 2024 are on the money, there is potential for a large USD down move because there is a strong sympathy for a more structural USD selloff, similar to the one that transpired after the dotcom megatech USD inflows slowed after the year 2000.

Observation Two

As we saw with crypto, where search interest and price peak in tandem every cycle, In the attention economy and speculative markets, attention and price tend to move together. Public interest in artificial intelligence peaked for the general public on April 22 (according to Google search data) and on July 13 for financial markets (according to Bloomberg coverage). MSFT’s peak (so far) was July 18.