Forex Turns Red Hot

The 5.3 trillion US dollar a day foreign exchange market (forex) went red hot in January.

Fortunes have been literally made and lost overnight on this market. The first few weeks of 2015 has been like no other. It started on January 15 with the Swiss National Bank (SNB) abandoning the Swiss Franc peg to the euro, which created a seismic shock on the forex. SNB had burned through billions of dollars on foreign exchange, buying euros and selling francs with the aim of giving their exports a heads up. However, they could do no more against the relentless tide so they decided to cut and run. On that day, the man who bravely bet against the Bank of England and walked away with fame and fortune, George Soros, had almost been squashed by the SNB de-peg to the euro. Shorting the Swiss franc was a profitable move before the SNB de-pegged. But somehow, call it premonition, or survival instincts or good “insider contacts”, Soros abandoned his short trade days before the SNB de-peg, then a few weeks later at Davos announced his retirement. Maybe he thought it was better to leave the casino with his boots and pockets full. Easily being amongst the top ten richest men on the planet, he has had a good spin of the wheel.

Although the legend may have bowed out, the trillion dollar casino continues.

Indeed, with such turmoil on the forex, the big punters are staking some mega bets.

Let's look at a few.

Denmark's central bank cut its deposit rate for the third time in two weeks on Thursday. They have joined the club of charging banks more to hold their money. It now costs banks more money to keep cash on deposits at the central bank. The Danish monetary authorities are trying to defend its long-established currency peg against a weakening euro, which has tumbled since last week when the European Central Bank adopted a EUR 1 trillion-plus ($1.129 trillion) stimulus package. Negative interest rates in theory discourage investors and savers from moving their euro cash deposits into the local currency, thereby depreciating the Danish Krone against the euro.

Some punters are wondering whether this is a repeat of the SNB abandoning its peg. Does the Danish Krone offer the next big opportunity?

The peg, which keeps the exchange rate within a defined range, has come under pressure as the ECB's stimulus plan weighs on the euro. The euro has fallen 6.4% against the dollar this year. Furthermore, the cost for investors to insure against volatility in the Danish krone has spiked, which could be an indication that more traders are anticipating a move.

Nevertheless, no two events are identical. Denmark's peg is a long-standing part of the country's policy. It used to keep inflation low and conditions stable for exporters. But the main difference to bear in mind is that, unlike SNB euro floor peg of 120, the Danish peg also has the support of the European Central Bank, which is likely to be defended under the terms of a European Union agreement.

"The peg is a cornerstone of Danish economic policy and has been so since 1982, and there is a very broad commitment throughout Denmark for the fixed exchange rate", said a central bank spokesman. The Danish krone was little changed against the euro on Thursday.

On Thursday, the dollar climbed to an 11-year high against a basket of currencies and is up 15% in the past year against the euro.

Moreover, some are arguing that there’s no guarantee the krone would appreciate if it were forced to abandon the peg. But I disagree. Apply the laws of logic or physics. If an object is being artificially held stationary, think of the handbrake on a vehicle parked down a steep hill. When the handbrake’s disengaged, gravity takes over and the vehicle rolls forward down the hill.

Likewise, if the Krone were de pegged, market forces would send it shooting higher. More “hot money” would flood in and the monetary authorities would be powerless to stop the trend. It would make a mockery of the terms of the EU agreement.

As I mentioned before, the currencies of countries with oil based economies are likely to continue in a downward trajectory. The Saudi Arabian currency and the United Arab Emerites dirham are likely to make profitable short trade opportunities, in this low oil price environment. At the time of writing this piece 1.00 USD 3.67305 AED Emirati Dirham.

Guggenheim Partners LLC, which manages $220 billion, is about to start betting against the currency of the United Arab Emirates, the dirham, said Scott Minerd, chairman of investments and global chief investment officer at the firm. Guggenheim is also considering betting against the Saudi Arabian riyal and on an appreciating Danish krone, he said.

The currencies don't float freely, meaning that officials in each country peg the currency's value to another currency such as the dollar or euro. So whether the bets pay off depends on whether policy makers will change course. The central banks of these countries aren't obviously giving the market any indications that they are planning to abandon their peg. Frankly, nobody knows what will happen. But assuming that Guggenheim Partners LLC hedge fund bets go sweet, the funds could make $1.5 billion of profit, if the trend goes the other way potential losses are capped at about $30 million, Mr. Minerd saIid.

The upside is more than 20 to 50 times the initial investment, based on 12-month options the firm will purchase, assuming the U.A.E. devalues its currency, Mr. Minerd said.

The trillion dollar casino continues. But notice how the old hands play; minimizing their losses and maximizing potential profits.

Interesting....