(As written for My Paper on 29 November 2011. Click here to enlarge)
Traders and investors are highly concerned about the on-going debt crisis in Europe.
What is the one crucial clue that is a clear indicator that risk? The clue lies in bond yields.
By definition, a bond yield is the return an investor would earn if a bond was purchased and held to maturity.
It also represents the interest the bond issuer has to pay to borrow the money. Suffice to say, the higher the yield, the more money the issuer has to stump out to repay the bondholders.
What drives yields up or down? Yields move inversely to bondholders’ confidence. When confidence is high, yields are low. When confidence is low, yields are high.
Countries with low bond yields typically exhibit strong fiscal and robust growth.
Let’s consider 10 year government bonds in Singapore and Greece. The yield is under 2 per cent for Singapore, but about 29 per cent for Greece.
This tells us that investors demand a premium to loan money to Greece.
Despite the bad news, all of the risk currencies – EUR, GBP, AUD, NZD and CAD gapped upwards against the USD when markets opened yesterday. This was mainly due to a report by Italy’s La Stampa newspaper, which reported that the International Monetary Fund (IMF) may be preparing a loan of 600 billion Euros (S$1 trillion) to Italy. However, an IMF official later denied the report.
Until a concrete plan is seen in Europe to stem the crisis, traders will remain short on the five risk currencies mentioned above.
Short AUD/USD at 0.9815
On the hourly chart, a range of 233 pips is spotted, with resistance located at 0.9894 and support located at 0.9661.
The bias is still to the downside, with a strong preceding downtrend, and with the Australian dollar being one of the first to react with on-going problems in Europe.
An entry is taken at 0.9815, 79 pips below the resistance level. A protective stop is placed 85 pips above the entry price, located just outside the range. We will have two profit targets on this trade, exiting the second and final position at 0.9645.
Entry Price = 0.9815
Stop Loss = 0.9900
1st Profit = 0.9730
2nd Profit = 0.9645