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EUR/USD, GBP/USD Daily FX Commentary September 10, 2012

We sure got the third push we were expecting Friday though I didnt get an entry. I must admit 170 pips from the start of the London session was a bit excessive. We did have a crappy NFP to help it out so as we start the week we will be looking for the reversal. If you look back over time quite often when we end the third push closing on the daily highs we at least see a pullback we can trade for some nice pips. Since I was up late Friday and figured once London closed for the weekend there would be a high chance for the pullback as they took profits so I set a pending order at the highs of the day thinking they might do a stop run first. Once I saw the  candle pattern showing the turn may be on I thought I would miss the boat. When I got up Saturday and checked my charts I was happy to see that not only was I in, but the market did close right at the highs. We will see if the probabilities are in my favor for at least a 50 pip trade. Im short from 1.2803.

If I was not already short I would be looking for the break of this minor support level around the 1.2780 level during Asia and then some manipulation into the Asia highs or the 80 level from the downside for a short. If I do manage to get my 50 pips during Asia there is still the posibility for a long on a stop run to the downside. Finding a good level will be the tricky part the support around the 1.2750 level is the most likely spot but we also have some Fib confluence at the red line of 1.2740 so we may see it get the stop run there.

The GBP/USD has extended to where I see 4 pushes to the upside and may be due for the reversal also. Its finding support at the lows of the end of the US session Friday as I type this and has closed the gap up today. If it does manage to break that support during Asia then the place I will look for a long is the 1.5980 level where the breakout occurred Friday. For any short position I want to see the stop run to the highs or a clear trap move at the Asian highs today. Preferably the highs with a nice hourly stop run candle.

Forex News Today

In short there is no high impact news today. We do have French Industrial Production and Sentix Investor Confidence from the Euro zone but with the market working on pricing in another round of QE from the Federal reserve I have my doubts these will have much impact.

Lets Talk Math On More QE 

Friday I found an interesting article on the real math and just what the Fed can do since they have been running Operation Twist for quite some time now. here are a few excerpts from it but its well worth the full read here.

The Scary Math Behind The Mechanics Of QE3, And Why Bernanke’s Hands May Be Tied

Here is the math.

As part of its Operation Twist, the Fed is buying long-term bonds, and selling short-term (0-3 years) bonds. As we reported in April, the biggest limitation for the Fed is that it is rapidly running out of short-term bonds to sell. There is a fix to this: the Fed will simply have to sell longer dated bonds from its SOMA portfolio, first up to 5 years, then 7, and so on. Of course, this will also force the Fed to extend its ZIRP language by an appropriate amount of time, through 2017, then 2019, and so on (which also means all bets that the Fed will hike any time in the next 5 years will be immediately null and void, and one can position accordingly in the Eurodollar space).

This move, however, will simply permit the Fed to extend Twist 2 beyond its year-end maturity. As a reminder, the primary role of Twist, aside from that stated one which is to keep the curve as flat as possible (i.e., boost housing which as we showed yesterday is not working, as refis have plunged recently despite record low mortgage rates), is to absorb virtually all the long-end supply: after all, it is all about the funding of the US $1 trillion+ annual budget deficit.

Said otherwise, when it comes to the 10-30 year sector the Fed is already monetizing all new issuance. This is part of the entire flow argument which we have been discussing for the past 6 months, and why we, correctly, say that Operation Twist is really QE 3 and QE 3.5 (for the recent extension of Twist). So far so good.

The shaded region is important for two reasons: this is where the Fed will be buying new bonds as part of any new QE Large Scale Asset Purchase program, and it tells us all there is to know about how big and how effective QE3 (really 4) will be. The bottom line, as calculated by UBS’ Michael Schumacher and confirmed by anyone with access to the detail behind the Fed’s SOMA holdings, which incidentally just hit a record 116 months two months ahead of Twist 2 schedule, is that “the Fed owns all but $650 billion of 10-30 year nominal Treasuries.” Also as pointed out above, Twist 2, aka QE 3.5 is already absorbing all of the long end supply. And herein lies the rub. To quote UBS: “Taking out, say, $300 billion in long-end Treasuries almost certainly would put tremendous pressure on liquidity in that market….Ploughing ahead with a large, fixed size QE program could cause liquidity to tank.

In other words, anyone expecting a full blown LSAP focusing only on US Treasurys will very likely be disappointed as the Fed will certainly realize, quite soon we hope, that it has only $650 billion in total 10 year + bonds available in the entire private market!

Well, perhaps the Fed will just monetize MBS, as Bill Gross has been betting on for nearly a year now. It could do that… but when once factors in “math”, the results are once again quite startling. Quote UBS again:

 The alternative of tilting purchases toward MBS implies that the QE program would need to be quite protracted. Monthly supply of conventional 15yr, 30yr and 30yr GNMA has averaged about $85-90 billion over the past year and the Fed is already buying about $25 billion. The Fed might be able to buy another $40 billion without disrupting the market. Assuming that the Fed does a $600 billion program with 75% in MBS, it would need to buy $450 billion in mortgages, so in our estimation the program would need to last nearly a year. 

Most importantly, all of the above actually confirms our biggest worry: the Chairman is well aware of the math behind this analysis, and is the reason why month after month he has been forced to pull a ‘Girl with the Draghi Tatto’ and jawbone the market into submission, hoping nobody else does the math on what Bernanke’s real options are, because once the details are out there, and everyone can do the math on their own, only disappointment can follow.

Interesting to say the least

Happy trading


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