06 August 2011

The Quality of Long Term FX Optimizations

What is the effect on valuation of maintaining an interest rate differential within a pair.  It might be expected that it biases directionality and gives what seems like growth.

That indeed does seem to be the case with EUR/USD, historically, at least up until the crisis. However it does not seem to be the case with USD/JPY, suggesting that there was something else at work with the Euro, growth contingent upon political developments in the EU.

But more interestingly it was perhaps a process dependent on the creation of a single currency market. What exactly does having a new market for a currency mean, well it means ways to value it need to be found, to those external references the forex market creates (for those on holiday as much as traders).

It could be suggested that the way this pair found valuation was to simulate a growth process, that is, it was in effect a search which found easy directionality, because there were few constraints on its valuation.

It is a state found in the market on a daily basis, in cases where money flow has sharply reduced valuations to a point where a trend begins, but not a bounce, but one well structured.

It is now difficult to value this pair (or perhaps to assume valuation) except structurally, just as it is very difficult to value companies in a market which is based on the movement of vast flows on money rather than on valuations based on the engineering quality of its statements (the effect of 10 years of information processing).

One might expect that financially pristine companies, within the constraints of the present economy (assuming these can be separated), would express structural order in their share movements, but be highly ranged. Similarly for currencies.

I have suggested that forex may contain pointers to equity valuations. Can one see in the lack of trended long term directionality of EUR/USD since the failure of the attempt to push it in the way it could be pushed prior to the crisis (something this blog warned about).

That is can one see pointers to a company led growth, but in the structure of its pricing behavior. That is, is there an increase in precision, is quality of optimization being evidenced in its pricing behavior (given both these currencies are conduits for flows in and out of the stock market).

What is quality of optimization. Let us assume it is a process that has a symmetry wherever it happens. Its quality is not anything to do with a valuation at a given time, its quality is precisely its solutions over time (that is the way the equity market taken as a set of statements works).

That could be seen as an optimization order in its pricing behavior. Note the money flow ordering given by USD/JPY discussed in the Analysis page and the lack of it in CHF.

To expect quality optimization, one would expect a structuring not based on order flow, not chaotic, not deterministic, but based on precise future valuations. That is, one would expect ranging, constraints on movements.

To grow is illogical for a currency pair, from the perspective of optimization. What kind of ranging, well, ranging perhaps like the gap between market closings. That is, a search for a valuation on which to value for the next open.

A world in which the US is getting its fiscal house in order, would be a new world order. The recent aversion of the probable disaster of default, along with the incentive given by a slight downgrade, suggests this has a greater probability of happening. That is the political system seems geared now toward making previously improbable solutions.

It suggests as well, the business as usual, that bias toward money flow enhancing assets values, may not be a state which can be returned to, at least in the same from it was.

For me that is reason for great optimism: optimized fiscal policy on top of the underlying strength of US business. The business of the US is business, as they say, perhaps now is the time and the great opportunity to focus fully on this.

The place for growth is of course in companies, this is where wealth is created, from those owning equity and seeing it grow. That means the stock market and security valuations. These are not meant to range.

It might be suggested that if quality companies are ranging, those companies which take flight, might have retracements. This is like the state of the economy up till the crash, which was essentially ranged and then massively retraced.

Within this range there was movement for large currency ranges, which equated to stable trends, such that they seemed attractive for long term positions. Whether this was actually the case is another matter, because the assumption here is that major retracements will not occur and it might be the case that one might to consider the opposite belief.

I might suggest that an economy growing in the *possible* manner it has now could exert a greater functional control over forex. However possibly increased randomness in the market could still make for major long term trending moves.

Would this hypothetical world be good or bad for the business of forex, relative stability I might suggest would be positive for it, volatile markets may seem to have profitability, but this is not necessarily the case in practice.

© 2011 Guy Barry - All Rights Reserved.