Buy the USD, but against which currency?

I still believe the US dollar will be stronger going forward and I think that its recent weakness presents an excellent buying opportunity. As I wrote in March 2015, there was no reason for the EURUSD exchange rate to go up at that time, unless the Fed would change course and oppose the dollar's strength. Well, that is exactly what happened, unfortunately:

The Federal Reserve has still not hiked rates and some even doubt that it will do so in 2016, while both the ECB and the BoJ have embarrassed themselves by botching up press conferences or entering negative interest rate territory, only to see their currencies go up in value afterwards.

The USD has lost versus most peer currencies, especially the JPY. It's still difficult for me to understand why people have been so concerned about the US economy lately. Every data release that was even slightly below expectations quickly led to more USD selling and EUR or JPY buying. As a result, USDJPY is now fighting not to fall below ¥105 (or even ¥100) while EURUSD recently tried to break above $1.15 (although it has so far failed to do so). The American economy isn't doing that bad, and market participants' obsession with the unemployment rate has reached an outright ridiculous level. At this point it's all about productivity figures!

Anyhow, speculative USD short positions are the highest since 2013. That's a good sign for traders: The extreme EUR & JPY short positions that were the cause of much volatility in 2015 have been reduced substantially, providing new entry opportunities without the risk of extremely sharp moves as in April and December 2015. Market positioning is way more neutral now, which is also a result of investors' inability to interpret central bank actions. Most likely central bankers don't really know what they're doing themselves anymore, so traders are now looking for new reference points that will help them navigate through the muddy waters that are the financial markets. Fundamentals in the US are still better than in Europe and Japan, despite the recent string of disappointing data releases.

But which currency to sell versus the dollar if you share my view? I don't really think the ECB holds much credibility in the markets anymore. Also, Draghi and his team have repeatedly said that they wouldn't introduce new policy measures in the near future because the implemented policy tools needed time to have an effect on the economy. Europe's central bankers are probably too busy discussing their independence from politicians anyway. I expect the EUR to remain range-bound for the time being -- although I must acknowledge that the sideways range in EURUSD has been going on for what looks like a disproportionately long time when comparing it to similar patterns in the exchange rate's history. Be that as it may, the BoJ seems more likely to surprise markets by introducing new easing measures. It is also in a very tricky position now where it has to make decisions within very little room for action around the zero bound. Just how negative can you go, after all? Japan's still fragile economy is in a tough spot here, and I believe both fundamentals and further BoJ actions will reverse the JPY's bout of strength into extended weakness by the end of this year. Conclusion: I'm a USDJPY buyer.

ECB and BOJ may soon buy equities, Reuters reports

As if central bankers hadn't done enough damage already, the masterminds at the helm of the ECB and the BOJ may be considering to buy equities via ETFs, at least according to Reuters. How did they come up with this brilliant idea, you might ask yourself... well, it is to "support market sentiment and stock prices".

With unconventional measures, such as helicopter money, already a part of the public (and perhaps even closed) debate about how to prop up our (so they say) worryingly ailing economies, this should not even be that surprising to be honest: The BOJ has already been buying ETFs, the ECB is buying up bonds wherever it can find them and the Fed has so far chickened out of raising interest rates (and killed forward guidance in the process, but that's another topic).

Let me ask this though: Why don't they simply buy oil, if deflation is really what central bankers are concerned about? Seriously, how does buying equities and thus pushing up stock prices help the average citizen? Doesn't it merely make the portfolios of wealthy people more valuable and hence widen the gap between the middle class and the rich (the playing field is already too uneven for the poor, so let's not even bring them into the equation)? I'm not a friend of conspiracy theories or leftist gibberish about "the 1%", but if stock buying were to become a viable tool for the ECB to "pursue its mandate", as our man Draghi likes to put it, I would really have to sit down and do some serious contemplating about how this market is now functioning versus how it is supposed to work. I thought we were living in a social free market economy, but perhaps I've just been too stupid to see what's been going on these past few years. If what we have right now is not a centrally planned economy, at least with respect to price formation in securities markets and increasingly even access to markets, then I really don't know. What else is there to say?

Money & Speed: Inside the Black Box

As a follow-up to February's video post about quants, here's a related documentary from VPRO that highlights the Flash Crash of May 6, 2010.

I vividly remember that Thursday evening when, as a risk management intern on a London trading floor, I witnessed the stocks of the world's largest corporations fall 10% and more in a matter of minutes. Markets had already been down 3-4% that day in the light of continued heavy protests in Athens. The atmosphere was eerie to say the least. On the day before, a group of angry demonstrators had set fire to a local bank, killing three employees who could not vacate the building in time. Every time the news channels resumed their live broadcasts of the violent protests equity indices and the euro dipped further. Starting at 1 p.m. New York time (6 p.m. in London) the prices of US equities began to fall sharply, triggering the first Liquidity Replenishment Points, i.e. circuit breakers, for several NYSE-listed stocks, and the chaos quickly ensued from there.

It is still not understood what caused the Flash Crash exactly, but an individual trader, Navinder Singh Sarao, who operated out of his parents' house in a poor part of London may have played a role (according to US authorities, anyway). He is currently facing trial in America after having been extradited by his home country.

Quants: The Alchemists of Wall Street

The VPRO Backlight documentary Quants: The Alchemists of Wall Street provides a casual insight into the work of quantitative traders and researchers, "quants" for short. It features Paul Wilmott, a quantitative finance researcher and consultant, and Emanuel Derman, author of My Life as a Quant and professor in financial engineering at Columbia University, amongst others.

What is MATLAB?

MATLAB is a high-level programming language used most commonly in technical computing, such as for numerical computation or algorithm implementation. Developed originally by mathematician Cleve Moler in the 1970s, MATLAB was officially released in 1984 and has since grown into one of the most popular languages for scientists and engineers. It is also frequently used in the finance industry, a popular destination for young engineers looking for a job.

Why is MATLAB useful?

Most importantly, MATLAB is based on LAPACK, a linear algebra software library originally written for the scientific programming language FORTRAN. As a consequence, MATLAB offers powerful out-of-the-box functionality for operations on systems of linear equations (i.e. matrices) that would be way more difficult to implement in a language like C or Java.

I would even say that programming in MATLAB will generally take less time than in most traditional languages, which is why it is often used to prototype new ideas. Good MATLAB code is relatively concise. You won't see as many loops or if statements than in other languages, for instance, and variable declarations can be neglected in the majority of cases (memory pre-allocation is important, however). This not only reduces programming time but makes the code easier to read, too.

Furthermore, you do not have to compile MATLAB code before you can run it. Much like in Java and Python, MATLAB programmes can be run immediately and you can even test code snippets directly in the IDE's command window. That is possible because the compilation and interpretation tasks are done in the background when you run your software. This can be a big time saver for large projects where each recompilation would take several minutes or even hours to complete, but it comes with the obvious disadvantage that interpreted code is usually not as fast as compiled code.

What are MATLAB's disadvantages?

First of all, it is often said that software written MATLAB is slow. That statement is simply not universally true. With its new just-in-time (JIT) compiler, which pre-compiles certain parts of your code before actually running it, MATLAB performance has improved a lot over recent years, resulting in run times that are perfectly acceptable for almost all applications. However, it is true that for certain high-performance tasks where every microsecond (or even picosecond!) counts, as in high-frequency trading, it is recommended to run compiled software. Still, most firms prefer to test their ideas in MATLAB (or R or Python) due to the aforementioned time savings during development before porting the software to C.

Second, MATLAB was designed specifically for numeric tasks. Unlike C, Java or Python, it is no general-purpose programming language. Therefore, MATLAB should only be used when actually doing maths or when working with data. The interfacing with other applications or the operating system, for example, should be left to another language that is better equipped for that particular task.

Finally, compared to the open-source languages R and Python, an obvious disadvantage of MATLAB is that it is relatively expensive. Lower pricing for academic institutions and individual programmers is available, but when you need to purchase many of MATLAB's toolboxes the total can still be significant.

MATLAB in Finance

Taking these positives and negatives into account, it may become clear why MATLAB is widely used in the finance industry today. Financial markets deliver a constant stream of data that can be analysed in MATLAB more quickly than in many other languages. Learning MATLAB is definitely easier than learning C. (It will still take a lot of hands-on programming experience to discover the language's intricacies that ultimately result in elegant and efficient code, of course.) The available finance and trading toolboxes allow for an easy integration of MATLAB into a bank's or hedge fund's workflow without the need of extensive interface development.

Future posts will explain the MATLAB programming language in more detail and also highlight how to apply MATLAB to the world of finance.