Tagged: FX

Hold onto your hats

As London was going home on Tuesday February 3rd, EUR/USD had almost hit 1.1500 – that’s up 3.5% from its post ECB QE lows. Prior to that, it had fallen almost 5% from the moment just before Mr Draghi stood up to give his press conference. It took 2 days to fall and 6 trading sessions to back up. No wonder most FX participants are feeling queasy. The trouble is, fx is caught between the negative impact of lower European interest rates, but the massive flow impact that the ECB’s policy unleashed into European equities. Those equities have now caught up with the performance of the S&P, if we measure it from when the ECB first moved to negative rates in June last year:

Eurostoxx vs S&P 3 Feb 2015

Here’s the latest data from BAML on European equity inflows:

EU equity flows

The potential for a correction kicked in on January 27th and the trouble is that the equity story is now dominating the interest rate one. Markets need new catalysts to continue a trend, and right now we are in a kind of hiatus. We know the ECB are easing policy, but so is everyone else (note Australia joined in last night, moving to a cut after sitting on the fence for over a year). The big question is whether the Fed really are diverging? Friday’s payroll report may give us some more clues on that but the latest US data is not encouraging with the bellwether ISM Manufacturing index moving down to 53.5 from 55.1. It may not truly become clear until Yellen gives her semi-annual testimony in a few weeks – will she want to indicate that they need to move off emergency levels or policy? Or that disinflation buys them time to wait and see if the better labour market data finally feeds into wage increases?

While this is all going on, an important new trend continues. Blondemoney has been warning about the return of volatility, and one of the big themes of this year should be that FX volatility stands out from other asset classes. Not just because of monetary policy divergence, but also the shift in commodity prices and the reallocation of global assets. Oh yes, and political risk too. Bonds and equities remain skewed by the ongoing monetary injection into the world, whereas FX can act as the pressure release valve. Here’s a chart of just how much fresh liquidity is being injected courtesy of the ECB and the BOJ, despite the pullback from the Fed:

Change in CB assets

Going back to our favourite cross-asset vol chart, FX vol is still sitting where it usually does, somewhere between rates and equity vol:

cross market vol 3 Feb

This is unlikely to persist. FX vol should rise from here. Some might say that it already has, given the shocks we have had from central banks so far this year. Indeed, global FX vol is rising – but only back to its long-term average. Here’s the JP Morgan measure of global fx vol, where the average is 10.68 since 1992, and we are currently at 10.90.

FX Vol long term chart

Of course, it feels awful, because back last summer we were making new lows sub 6%. An almost doubling in volatility is going to feel pretty significant. As you can see from the long term chart, the last time we lurched like this, it was the end of 2007 going into 2008…and yes, back then, FX vol was higher than equity vol:

cross asset vol credit crunch

Bond vol was high then too, but we all know the credit crunch originated in the debt markets, so that’s no surprise. This time around, it’s FX that will be the focus, given how liquidity is just trying to find a return wherever it can.

Blondemoney would argue that the price action since the ECB is not a one-off. It will come to be normal. Retail flows were wiped out by the SNB debacle; fixing scandals and regulatory change mean that banks can no longer offload positions or warehouse risk; and there is an awful lot going on this year to move the market around.

EUR/USD daily high frequency vol has moved higher, but only back to the levels of the end of 2011:

EURUSD HF vol

Again, it feels a big move because we are coming from such low levels.

But if you just look at the candles on EUR/USD in the past 6 months versus those of the last time we were up at these vol levels, at the end of 2011, you can see that price action was pretty choppy back then – the y axis has been adjusted so that both are on a similar scale:

EURUSD 6 months to date EURUSD 6 months to end 2011

Looking in more detail, we can see that the daily ranges in EUR/USD were indeed bigger back then. The average for the past 6 months has been 96 pips (i.e. one big figure), whereas in the 6 months to the end of 2011 it was 170 pips:

EURUSD daily range 6 months to Dec 2011 EURUSD daily range 6 months to 3 Feb 2015

Now you might argue that at the end of 2011 we were still muddling through the Eurozone crisis. In fact, we were nearing its end, with five out of the 17 eurozone countries already seeking aid. Just 6 months later, in mid-2012, Draghi announced he would do “whatever it takes” to save the Euro.

This time around it’s not about a crisis for one part of the world. It’s a systematic shift in how foreign exchange is operating between global economies. Corrections are about to become more savage – and that long dollar position might have some time to wait before the interest rate story provides a renewed catalyst. Here’s the extent of that position:

USD position IMM

And here’s a chart of the key tech levels we are sitting on in the dollar index:

DXY 93.68

A 1 month EUR/USD straddle costs around 280 pips at 11.1 vol.. If we’re moving back into a higher vol regime then we should get used to 3 big figure moves over the course of a couple of days, not a whole month.

Hold onto your hats….

 

Don’t hit the sherry too soon

It always happens when you least expect it, doesn’t it?*

And lo, so it was that the dollar did rally up to the highs of the year, just as the market had hoped on January 1st but had suffered in want of for most of this blessed year.

While shepherds watched their flocks by night, they were stopped out of their dollar longs and then did focus instead on the mysterious light that appeared, rather than re-establishing those positions.

An angel of the lord came down, and told them not to be afear’d. The isle is full of sounds and strange noises. “Is there more toil?” cried the market. “Let me remember thee what thou hast promised, Which is not yet performed me”.

A promise unkept can be charted thus:

IMM divergence

 

The pink line is the net combined US dollar index position on the IMM, while the blue line is the dollar index itself. Note the divergence in the past month. The position has been trimmed just as Janet Yellen gave the most hawkish press conference of her time as Fed chair, and just as Draghi revs up the ECB QE engine.

This year may have left you desperate to reach for the Christmas sherry, but it may be too soon for that. Note that GBP/USD is currently settling sub 1.5600 – yesterday it closed below there for only the second time this year. If we take out the previous year’s low at 1.5541 today (currently only 25 pips away), then that should provide another catalyst for a stronger dollar from here.

With apologies to the Bible and William Shakespeare for the opening prose

 

 

 

The Day Today 2 Oct 2014

Stock markets a sea of red, the dollar in reverse, but most significantly the US 10yr closed below the key 2.45% level. Are all of September’s positions about to be reversed?

* There are certainly positions out there to be reversed: Parker Currency Index up 3.29% in Sept, biggest monthly gain in 10yrs {fifw NSN NCSDF46JIJUP <go>}

* Do we care about details of the Draghi plan? He has committed to raising the ECB balance sheet by 1trn. Last night he invoked Hercules’ defeat of the Hydra – new problems keep popping up and you must tackle the problem “on the surface and at the root”

* BOE’s new MPC member Kristin Forbes makes her first public speech: “does [the current level of CPI] incorporate a substantial drag from the past appreciation of sterling? If so, inflation could increase quickly” but then she balances with “Or is any such drag currently small or likely to persist for an extended period? If so, inflationary pressures could remain muted, thereby providing more time before an adjustment of monetary policy is appropriate.”
* She also said currency strength was affecting the Fed: “This has already prompted analysis and discussion by the [Fed] of how this could present challenges for the economy and US monetary policy”

* Fed’s Evans: “I am very uncomfortable with calls to raise our policy rate sooner rather than later”. Reiterates they need to be “exceptionally patient” about raising rates, arguing they need to make clear the 2% target is an average so inflation can run ahead of that as well as below it. He doubts they’ll agree on a ‘grand recasting’ of the FOMC statement

* Former FinMin Fujii says further JPY weakening may trigger intervention

* RBA Edey: macroprudential measures to calm the housing market is “unlikely” to involve loan-to-value caps like NZ

* A source suggests the Chinese want the HK govt to wait out the protestors

* Fears of Ebola in the US escalate

* Do the math on the bond mkt:
– avg daily trading last year $809bn, down 20% from 2008
– but global bond mkt ~50% higher since then
– Gross leaves PIMCO, Mexican Govt bonds -0.3% while BAML Broad Index down just 0.05%

* PIMCO announce the Total Return Fund lost 10% of assets in Sept [and Bill Gross only went 2 days before month end!]

The Day Today 1 Oct 2014

* Japan Tankan survey:
– Boost investment by most since 2007
– But non-manufacturers and small businesses show deterioration in sentiment
– Employment index shows tightest labour market since 1992
Japan Tankan Employment
As USD/JPY hits 110, Japan officials rhetoric shifts:
* Econ Min Amari: Excessive currency movements undesirable {fifw NSN NCQZ9H6KLVR9 <go>}
* Dep Chief Cabinet Sec Kato: Watching Yen’s movements closely {fifw NSN NCQVU26S972C <go>}
* Nikkei: Once seen as boon, falling yen may now be bane to Japan Inc. 80% of SMEs see $/JPY at 109 as “undesirable”

* BOE’s Miles suggests spread between mortgage rates and BOE rate might stay wide: ‘If you don’t have to increase Bank Rate as much to get higher rates in the real economy, you don’t have to increase Bank Rate so much’. He also says more fwd guidance could cloud the picture

* Draghi pushes for ECB to accept Greek and Cypriot ‘junk’ loan bundles http://on.ft.com/1uAoZen but Germans resisting
* Negative rates prove challenging for European money mkt funds, with S&P warning of a downgrade from their solid AAA status if they break the buck

* Fed’s Evans: “We’re going to take [a stronger dollar] into account” [it certainly boosts the argument of the doves]
* WSJ: In Significant Test, Fed Facility Fails to Defend Short-Term Rate Floor

* IMF Global FX reserves see USD rise to 60.66% from 60.34% in Q1, and Euro fall to 24.19% vs 25%, and that’s before the ECB moved to negative interest rates {fifw NSN NCPYZW6LUTXE <go>} AUD and CAD holdings up 17% from a year ago

* Islamic State ‘now controls a large chunk of Iraq’s wheat supplies

* China loosens mortgage rules

Remind me, how do we trade a trend again?

The last few weeks have felt like a real market again, as a number of you have remarked to me (often a little misty-eyed). FX volatility is up and the dollar has been on the march. For those keeping count, it’s been the longest winning streak for the dollar since 1967. For the technically minded, the weekly RSI on the dollar has only ever been higher twice since the financial crisis. When this relative strength index has moved back below the 70% level that has heralded a short sell-off in the dollar, as this chart going back to 1997 shows [it’s the lower panel that measures the RSI]:
Dollar Index RSI
So will the dollar strength last? Given we are at such stretched levels, it’s likely we may consolidate in the short term, although this chart suggests that we would only see a more significant sell-off once the 70% level has been breached.

Fund managers feel frustrated however. They just don’t have enough of this trade on. Blondemoney is yet to meet anyone who is significantly long of USD/JPY, despite its 5% rally this month, and even as it approaches 110, most people’s dream target in January. As ever, the moves happen when least expected. The demise of FX Concepts may well turn out to have been the unfortunate marker for the turning point in FX markets. Fewer players chasing the same returns, accompanied by the start of significant divergence in interest rates, makes for profitable times ahead.

The trouble is, everyone has forgotten how to trade a trend. With volatility killed across asset classes this year, investors had to be cautious about holding any kind of time decay. In FX this manifests itself with the proliferation of range trades. The morning after the destabilising Scotland poll, Blondemoney met a trader who had been knocked out of a Cable Double-No-Touch option. With Cable 1 month vols spending most of the year around 5, it’s perplexing why anyone would have chosen GBP as the vol to sell, particularly over a period that included the run-up to a referendum, but this is the year that everyone was painfully reminded of Keynes’ maxim that “the market can remain irrational longer than you can remain solvent”. You just had to sell any vol that looked expensive. With all these range bets in the market, that means stop-losses build up.

Even for those playing the trend, a difficult year has made them quicker at taking profit. Back in the day of cojones, positions and leverage were increased as a trend was established (more from Blondemoney on how the market had lost all confidence back in early August here). Now, you get in, take your money, and get out.

This suggests that we are at the start of a new chapter. Investors are re-learning about life without central bank support. The patient is up off the operating table, but needs some physio to remember how to walk. This is not a false dawn. Volatility is coming back across all markets.