EUR/USD: Currency Markets in the Future

As currency markets enter year 45 since the 1971 free float and as markets approach crucial year 50, higher volatility and calls for market crashes are only natural historically as the current winter of markets presage a new period ahead. The ECB threw the initial volley and instituted the first structural market reform in 17 years by movement of the traditional currency Fix price from 8;30 am NY to 10 am in line with the 10:30 am Gold Fix. The argument in this post is markets are heading for a new undecided period, possibly a gold period, possibly a Gold / Silver Ratio compression of the current Gold / Free Float phase in existence since 1971 and possibly what I see as a stable period where volatility no longer exists because price movements slow to a dead crawl.

Movement of the ECB Fix from 8:30 to 10:00 July 1 is one part of not only the slower momentum of currency prices but the release of European interest rates from 7:00 am NY to 5:30 am guarantees slower price progressions as long as currency prices are reflected in interest rates. What allowed Fix time change is all central banks for the past year studied restructure then delayed by 24 hours the release of their respective interest rates to the public. The Bank of Canada was the last to capitulate March 2015 as Thomson Reuters and Bloomberg exist as the outlets for real time data. Central banks with few interest rates such as Singapore completed adjustments. Malaysia Bank Negara is in a yearly process to adjust AOIR overnight rates, China is a work in progress while USD is scheduled to introduce another interest rate. Most central banks operate with few interest rates and don’t need adjustment because their systems are market oriented. Interest rate delay is not necessarily the story as much as the further movement for central banks to eliminate wholesale categories in respective interest rate curves and methodological changes.

The ECB as the most important money center to the world historically and most transparent in interest rate reporting was the first in March 2013 to eliminate seven of the 15 total interest rate categories. All central banks followed as integration and interconnection became the norm upon Euro introduction. Key changes ahead beginning July 1 to coincide with Euro Fixes is not only further elimination of the 2 week, 2 month and 9 month maturities but interest rates switch from quote based to a market oriented transaction based rate setting benchmark. Interest rate Fixes as the new movement in all central banks will anchor to transaction volume, controlling of course to volatility. Ranges compress as banks ability to bid or sell maturities outside market lattitudes will be severely limited.

The 10 am Fix means Mumbai becomes the new prevalent rate as the 12 pm Fix coincides to 1;30 am NY and 7:30 am Europe. Volatility seen at European news events were the result of not only the release in itself but the announcement coincided to release of Libor and European interest rates. Subtract the ability to reprice currencies in smaller ranges by Libor and European interest rates then news events lack the same volatility once seen. Libor was once the central interest rate governing the system of currency and all market prices because it was the center of floating rate corporate loans but it no longer holds its pricing value and its delayed by 24 hours so a power shift occured back to central banks to re- design internal markets and currency price systems as they desire.

Redesign of interest rates as the center of markets is paramount to redirect corporate loans and strengthen bank funding abilities by borrowing and lending. In the September 2014 speech “Life Below Zero” by ECB board member Benoit Coeure, the original purpose for negative Eonia was to force banks away from ECB loans and to deal direct in the private market. Restructure of current European interest rates is suspected as the next phase in the overall European plan and its natural for all central banks to follow the market leader.

Historically, structural market changes always derived from Europe alongside the common 300 year theme to add, subtract and /or control Inflation. The UK formed the first central bank in 1694 followed by Scotland in 1695. Gresham’s Law in operation and valid for the modern day occurred when Sir Isaac Newton overvalued Gold in relation to Silver in 1717 to a 15.5 to 1 ratio. Europeans called for the 1933 London Conference and requested US President Hoover assist to add Inflation in late 1920’s. The UK adopted the Gold Standard in the 1820’s while remainder world nations embraced Gold Standards from 1870 – 1914, 1914 to 1933, 1933 to 1946, 1946 to 1971. Europe adopted various Silver standard periods, 1750 to 1870. Greece, Bohemia – Czech Republic and Spain are traditional Silver nations. EUR/USD remains a pure Silver currency. Outside Europe, China, Japan, Korea, Hong Kong and India are Silver nations. Mexico is a Silver nation.

What structurally changed in past generations was revaluation of Gold to Silver or Silver to Gold and viewed as as ratios to fight Inflation and it emanated from Europe. The current free float period is an experiment based on standalone prices of Gold and Silver, Gold/ Currency, Silver /Currency, Silver/Gold Currency, Gold/Silver Currency and centered by an interest rate rather than a fixed Gold price. Control an interest rate then dominion exists to control currency prices. Lose control of the interest rate then markets crash including Gold and Silver because its just another currency backed by an interest rate. Through the ages, the current adoption of Fix standards has an historic context and is not new in the larger picture.
What governed the Fix system in the 1970’s, until unifying Libor in the 1980’s, particularly the many European currencies such as the German Duetchemark, Italian Lira, French, Luxembourg and Belgium Francs, Spanish Pesetas, Netherland Gilders was the Buba Fix and released 11:00 am Europe for the purpose to balance supply and demand particularly among corporate customers. European currencies had all the flow because the US failed to provide liquidity and because the US neglected to allow US banks to deal with International brokers until 1978. European currencies were separated as Financial and commercial such as Belgium Francs, Italian Liras and Spanish Peseatas A and B. Finnish, Canadian and other national banks didn’t deal direct with each other or even across borders so arbitrage opportunities existed. UK had exchange controls, a legacy holdover from the Gold Exchange Standard derived from the 1922 Genoa Conference when 1.4860 GBP/USD was overvalued to USD 20.67 Gold. GBP/EUR wasn’t yet a cross rate as is known today but was instead a non resident GBP. What stabilized the Fix system and currency markets to a degree was not only Europeans but Euro introduction.

Deficient was true price discovery before Euro introduction until the 8:30 Fix offered structural reform with assist from computer screens as past generational trades were conducted by telephone and Telex. A system developed from Mumbai to European interest rates, European news, Libor to 8:30 Fix. Then began American markets as news, 10:30 am Gold Fix, 3:00 p,m Gold fix. Today, Euro is fixed 12 times in a 24 hour period, 14 times to include Gold, 16 times to include Silver Fixes and more to include other central banks. The implications measured from January high to highs, EUR/USD saw + 1000 pip years six times since 1999 and only two times in post 2008. In four years since 1999, EUR/USD saw + 1500 pip years while pre Euro as DEM/USD saw one year in 1990 of 1500. Only three times in the 1990’s were +1000 pip years seen. The changing dynamics of EUR/USD is found in its on again off again correlations to Gold as 1998 – 2008 correlated while 2008 to present lacks correlation.

As central banks lost control of currency management and failed at Inflation concepts to cause crashes and wholesale market changes based on activism, the next crash is extremely close.
Market crashes occurred in 1873, 1884, 1893 and 1907 or four crashes within the 44 year market period from 1870 – 1914 and a crash on average every 11.3 years to set the modern day standard. From 1820 – 1870, The UK’s 1820 Gold standard to 1870 when all nations adopted Gold, 50 years then a change. 1870 to 1914, 34 years then a change. 1914 – 1933, 19 years then a change. 1933 – 1946 Bretton Woods, 13 years then a change. 1946 to 1971, 25 years then a change. In 151 years from 1820 – 1971, four crashes occurred and five wholesale market changes. Exclude 1820, then 101 years experienced four changes and four crashes.

.If the December 1971 Smithsonian Agreement measured as the free float commencement date, the current term enters not only year 45 but possibly market shifts, crashes, wholesale changes and currency pair realignments may conceivably be viewed as 12.5 years when separated in four quadrants, the 4th quadrant representative of the final period. As such, possible turning points, crash dates, change dates, end dates since December 1971 would occur in 1983, 1995, 2007, 2019 and 2021 as the 50 year end point. From January 1972, possible turning points, crash dates, change dates, end dates would transpire in 1984, 1996, 2008, 2020 and 2022 as the 50 year end point.

Predominant market arrangements endured from the 1971 Smithsonian Agreement to the 1985 Plaza Accords then from the 1987 Louvre Accords to the December 1994 Mexican Peso crisis.Wholesale market changes occurred in 14 then 2 years. Market crashes since 1971 materialized in 1987, 1994, 1997 Thai Baht, 2001 and 2008. Year 2008 qualified not only as a turning point but enter in the 4th quadrant and the most dangerous period for markets because of its historic representation to experience crashes and wholesale changes. Viewed historically from BOE inception in 1694, Sir Isaac revaluation to Gold in 1717 or any Gold period, the 4th quadrant is here.

Compared to 1870 – 1914 to four crashes and four wholesale changes, 1971 to current 2016 experienced five crashes and three wholesale market changes by agreements. From 1870 to 2016, overall nine crashes occurred and seven market changes. The period 1870 – 1914 when 11.3 years saw crashes, 12.5 fits closely to the current period yet the average of crashes and changes was lowered to 7.5.

Initial tests of the European interest rate changes based on the five prevailing rates reveal a severe slowdown ahead as EUR/USD ranges compress from current 70 pips per day to around 24, a 1/3 compression. Failure to sufficiently inflate the currency price to the interest rate allows ranges to compress as well as the additional extension of the Fix to 10:00. Further tests however early stages reveal EUR/USD could easily become AUD/USD and NZD/USD with daily movements reported in percentages rather than point terms such as the occurrence in Oil markets. Most interesting so far is trends will become vivid. The five European rates coincide to USD’s seven Commercial Paper rates, 10 if Eurodollar deposits are included. As hybrid Silver/ Gold currency pairs, AUD and GBP are governed by seven rates and eight for NZD. Markets are further integrating and as always historically with United States accomodation.

To switch to Gold standards would mean passage of laws in respective parliaments and Congress. The Euro area retains its same in millions 6,030 Troy oinces and the ECB 3,500. Both are unchanged since about 2009. The Fed owns 261 million + in Troy ounces valued over USD 11 billion. Only Silver nations Russia and China are actively stockpiling Gold. Beneficiaries of furture Gold standards would be China, Russia and the United States. As the interest rate controls current markets, the Gold standard is already here. But Gold Silver Ratios at current 78 serves as a warning because of `first ever achieved 1940 and 1990 highs at 97.81 and 93.33.

What would cause a crash and market change is an out of control money supply because its connected to not Gold as in past generations but an interest rate. The ECB M1 money supply began 1971 at 9.83, jumped to 21.83 by 1979 and zero at the 2008 crisis. Today, M1 sits at 11.2, inside a 10 – 15 historic band since EURO inception. Pre 2008, from 2002 -2006 M1 was inside the band but below for most of the period from 2000 – 2008. The 2008 crisis exploded M1 higher. As Eonia went negative September 2014, M1 rose back inside the band. Furher negative means a continued rise and not a healthy development to economic recovery. USD M1 is current 3,077.2 Billion, exploded in 2008 and 2009 from 1,399.8. All important Velocity from Q3 2015 sits 5.919 and 5.240 at the 1971 free float. The Velocity band since 1971 is a 6 -10 and is currently at historic lows.
What M1 reveals from both the ECB and the Fed is not disaster, not recovery but not confidence in an economic direction as both M1 are not in economic trend modes. Its a stasis condition. Add stimulus and maintain high money supplies then goals of increased Inflation and interest rates cannot be met. The next period, the next crash could very well be the result of deflation rather than inflation. Years later, 2% Inflation targets hasn’t been seen while 3% GDP was last seen in 2006 for most central banks. We’re in the correct period for changes and crashes. It doesn’t mean a crash comes today or even 6 months or 1 year but it means markets are in a dangerous zone.

Brian Twomey

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