Fed Day and the longer term picture

It’s Fed Day today, otherwise known as the day that all the crankiest, smuggest of all participants are screaming over each other to claim the end of the world, with an accompanying chart that has a trend-line that was broken or chart of the recent selloff of the DXY, with no further context.

What follows are hoards of Middle Skill traders rushing to their TD Ameritrade accounts to buy MORE puts on SPY, TSLA and some complex option structure on Eurodollar Futures (not EURUSD).

Who know’s, this time they may finally be right!

Rather than get everybody all worked up about the Dollar collapse, China, Covid19, the US Presidential Election, and a thousand other obviously priced in events let’s have a look at where we are historically in all the currencies. 

Here's the $DXY monthly chart

The first thing I notice is that we are pretty much at normal historical levels today, perhaps even up to the top end of those normal levels. The two big spikes way out of the normal range higher happened around 1985 and around 2001. The big move up started in 1980 and broke out dramatically higher in 1982. The Federal Reserve raised interest rates to highs of 19% causing a big recession in 1981-1982. 

The next big spike happened after the Dot Com bubble popped and 9/11 happened spending the next 10 years at historically low levels. Seeing things like the Global Financial Crisis, the US Debt Rating downgraded, QE1, QE2, helicopter money, and Crude prices near $150 per barrel.

But what's most notable to me right now is that we are right smack dab in the middle. Not extremely up or down, doing what currencies have done historically, stabilized in a range. 

For context, let's have a look at the other main currencies to see where they stand historically.

EURUSD

Again we draw a line down the middle and we see that, yeah, things are pretty balanced right here for EURUSD.

JPYUSD (Usually it's USDJPY but I put the other currency first to better compare)

Again, Japan right smack dab in the middle, and actually quite compressed as we speak.

AUDUSD

Aussie is a bit subjective, but it is bouncing hard off the bottom range but depending where we draw the line, pretty close to being at the mean price. 

NZDUSD

Samezies for the Kiwi. 

CHFUSD (again reversed for comparison)

Swissy is a completely different story than all the other pairs we've looked at. We know the broke the peg a few years ago but even without our trusty straight line down the middle this looks different than all the others. 

GBPUSD

Finally something interesting. The Pound is at near all time lows vs the Dollar, and yeah given everything that's happening with Brexit, this is expected. 

If we trade off of the assumption that currencies mean-revert more than they extend trends over the long term, long Cable is a really great risk reward. 

For further context to what I mean when I say currencies mean-revert let's look at what trend extensions look like.

SPX

It's true equities do mean revert for periods of time, 2000-2010 for example, but since 1871 the bigger trend is higher. 

This isn't an argument for or against equity indices, the incentives for equity indexes are to go higher, they are built by design to kick out the weakest performing companies and bring in the stronger ones. Given that incentivized optimization, indices have to appreciate in price.

Comparing how currencies are all balanced (minus CHF and GBP at the moment) and the velocity equities are flying higher, by having your money in cash you are effectively short the market. You are losing buying power. 

DXY/SPX (US Dollar vs SPX)

In other words, holding US Dollars vs just owning $SPY you are down about 95% of buying power since 1986. 

Better said, if you had $100k in a safety deposit box in 1986, that could've bought you back then, what todays $1,000,000 in cash can buy you. $1m is the new $100k.

Tying all of this back in to systems trading. When designing a system, understanding the underlying incentives of a given asset class and market will help you better design the strategy ahead of time. 

Given these examples above, currencies mean revert most of the time with bouts of very fast and steep breakout trends. 

On the other hand equities trend, Up, most of the time. 

Designing strategies around these incentives gives you some added wind behind your back to make trading a little bit easier, stacking edges as we call it in the Lab. 

Trade for short term income, invest for long term wealth growth, hedge (Gold, Bitcoin, Real Estate) for safety

The next time you see a ominous trendline on a Bloomberg chart of $DXY, remember what our longer term chart looks like. Take a breath, and get back to building and trading a well built trading system. 

If you want to build your own strategy the Systems Mastery Course can help you take these ideas and perspectives above and turn them into a quantitative results.