Saturday, 20 December 2014

Consensus-ing agreement in FX markets in 2015

10:37 Posted by The Thalesians (@thalesians) No comments

Why is Manhattan real estate so expensive? The simplest explanation is that a lot of people want to live there. There seems to be a consensus that Manhattan is a great place to live. At the same time, supply is relatively constrained. Yes, developers are continually building higher, providing more apartments, but many of these are to the upper end of the market.

Despite being such a desirable place to live, it might not be the right place for everyone. Perversely, the fact that it is so sought after and hence relatively crowded, results in a scarcity of certain amenities that we can find elsewhere. Want a garden? Central Park is likely the closest thing you'll get. Want a house? You'll likely have to share it. Want some quiet? Again, try Central Park and not the streets heaving with traffic, punctuated by the sound of car horns.

Depending on your viewpoint, these compromises are either too much to make, or for someone like me who has lived in a city for twenty years, entirely reasonable. We could also argue that the fact that Manhattan is crowded, is the reason people want to live there, and which makes it so lively. So often the word crowded has negative connotations, that the benefits seem to be forgotten. Whilst real estate is an asset class, when it comes to your own house or apartment, a primary concern is to live in it (whilst hopefully benefiting from rising house prices). When it comes to financial markets more broadly and investing, the idea of consensus and a crowded market can be more nuanced.

If we think of the market today, particularly in FX, the consensus for market moves is deafening. Despite reading numerous bank views in the media, talking to many contacts in the industry, scanning Bloomberg and Twitter on a repeated basis, it's been incredibly difficult to find anyone who is bearish USD in 2015 (think I only managed to count one so far). The consensus is overwhelmingly bullish USD, and this is made even clearer by the forecasts from the various sell side banks available on Bloomberg, which as a group see EUR/USD lower and USD/JPY higher. I also agree with them, although I think we're closer to the end of this USD bullish move than the beginning.

After all the rationale behind the view is fairly simple: the Fed likely to hike, the ECB likely to embark on full blown QE and the BoJ engaged in QEn (where n might end up being a large number, if I'm being really facetious). If you'd like to read my fuller thoughts on 2015 please download my latest Thalesians quant paper (free to download given it's Christmas!)

Does this necessarily mean that USD will actually strengthen? Of course, if we look into the past, the market has been bearish EUR/USD for a while. In 2014, the consensus view finally worked. For over a year before it evenutally fell, EUR/USD seemed to be driven more by peripheral spreads tightening following Draghi's promise to do "whatever it takes", rather than more traditional drivers such as monetary policy expectations. As a result EUR/USD had remained stubbornly bid. Even though in 2014, forecasters saw the move in EUR/USD, they failed to see the move lower in UST 10Y yields, I suppose you can't have it all!

So should I be afraid of being with the consensus? Furthermore, will the fact that the consensus is so strong for a bullish USD view cause a crowding of positions and a potential for painful unwinds? I have no easy answers, only to say that these are questions every investor should be asking. All I would say, is being on the side of consensus is always "safer". Even if you get it wrong, many others will be in the same group. If you are against consensus, it is far more difficult to rationalise a loss to your boss! Also, we could argue that simply fighting the consensus and the broader market narrative, simply for the sake of it is questionable. (Of course, if we think the market narrative might change and use that as a reason for going against the consensus that is an entirely different matter!)

Best of luck for 2015. Whilst luck is key for trading, it cannot be bought by skill!

My book Trading Thalesians - What the ancient world can teach us about trading today is out in late October on Palgrave Macmillan, has some colour on the topic of consensus in markets (mixed in with a bit of ancient history). You can order the book on Amazon. Also read my thoughts in 2015, in my Thalesians quant note here (given it's Christmas, I'm giving it out for free!)


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