Tagged: Market Madness

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:


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….


The Day Today 21 Jan 2015

* Bill White, the man who predicted the financial crisis, warns the current situation is even worse: “We are holding a tiger by the tail”; and that more QE won’t work: “Sovereign bond yields haven’t been so low since the ‘Black Plague’: how much more bang can you get for your buck?”

* Greece deposit flight continues: 1bn on Monday, 850m on Tues (the record in 2012 was 2.8bn) – total deposits now 152bn, vs 150.5bn in 2012

* NZ inflation turns negative for first time in 2 years, -0.2% in Q4, unch was expected

* BOJ cut their inflation forecasts, increase their GDP forecasts, say “inflation expectations appear to be rising on the whole from a somewhat longer-term perspective”

* QE is already working? Spain issues record amount at record low: 10 yr at 1.66% yield, down from 4% a year ago

* How investors are positioned for QE (according to SG survey):
– 70% expect QE, of amounts from EUR 500bn-1trn
– Euro and bonds both not yet pricing it in
– More sellers of EUR/USD rallies than buyers – expecting 1.1000
– 19% expect Grexit
– Peripheral bond yields – some expect to fall by another third

* ML Fund Manager Survey:

– Lowest cash levels in 6 months, despite vol
– 72% expect ECB QE
– 45% see oil as undervalued, the most in 6 years
– Fed hike seen in Q3 from Q2 in the last survey

* Poland launches enquiry into Swiss mortgages: 550,000 Polish homeowners hold $36bn worth of CHF mortgages

* The National Futures Association is considering whether to review leverage limits for FX trades

The dust hasn’t even vaguely settled

….but this is what we know so far:

1. Yesterday queues were forming in Swiss banks, but more interestingly, at bureaux de change. Deeply negative rates and a massive currency appreciation are not lost on the Swiss people – get your swiss francs out of the bank and turn them into euros or dollars. Pics from Twitter – the first is from Geneva, queue began forming from 5pm, second is Cantonal Bank of Zurich:

Geneva fx Cantonal Bank of Zurich


2. A number of FX brokers have either gone bust, are teetering on the edge, or are nursing huge losses:
* FXCM (big FX broker, $1.4trn trades last quarter) says it lost $225m and is trying to shore up its capital
* Excel Markets (smaller broker who trades as matched principal) closes down as clients lost so much money they were unable to cover it
* IG Index says it could take a hit of £30m
* Alpari has gone into insolvency

3. Banks and hedge fund losses are only just emerging:
* It forced Greek banks to apply for Emergency Liquidity Assistance (along with other issues such as election risk deposit withdrawals and foreigners no longer buying T Bills)
* John Hancock Absolute Return Currency Fund loses 8.7% according to Bloomberg ($1.9bn assets under management)

But we all know this raises more questions than answers:

1. What does it mean for other pegged or semi-fixed FX regimes? Intervention is like a red rag to the currency market’s bull, and they just gored one of the biggest central bank matadors. All eyes are on USD/HKD, USD/CNY, EUR/CZK and EUR/DKK

2. What does it mean for other central banks who are ballooning their balance sheets? It’s widely believed that the SNB frontrun ECB QE which is now seen as a done deal (frankly it already was), but the bigger change could come from the BOJ. The Nikkei reported yesterday that some on the BOJ feel that QE costs are outweighing the benefits: the 5yr yield at zero is causing massive problems for the insurance industry who just can’t find enough returns to support their business

3. What does it mean for deflation? Well, economists estimate it could reduce Swiss GDP and CPI by 1% – with rates already at -75bp what will they do next? Our pictures from twitter show what happens when you distort the price of cash in this way – it’s better to get hold of notes and coins. But just as Japan were exporting deflation by weakening their currency, this could mean ultimately that Switzerland exports inflation. But that is some way down the line.

One thing we can be certain of:

Central bank credibility is dead, and market volatility is here to stay.

The Swiss Franc is a major currency. But it took only 20 minutes yesterday for it to move as much as the rouble did in a month.

This kind of price action is frightening. Some of it was driven by option traders – exotic option books had not hedged all of their deltas because they couldn’t agree on what deltas to exchange below 1.2000.



This is second by second data, and it was moving down and up 5 big figures. That is not normal.

Welcome to the new normal…



Why the Swiss decision is even more momentous than you think

With a one-page statement, the Swiss National Bank just pulled the rug out from under EUR/CHF. The trouble is, they’ve pulled the rug out from more than just that.

You know by now that Blondemoney is an optimist, but today’s events will cast a very long shadow. This could be the moment we all realise that the Emperor’s shopping bag is empty, there simply aren’t any new clothes. Why?

1. Central banks have now tried forward guidance, QE, negative rates, and currency floors. None of them are working.

2. All the economies that were already struggling with deflation have had central banks dragging their feet about taking action. The SNB sat and waited for months before they decided to follow the ECB with negative rates; the Riksbank still haven’t got there yet; while Poland say they’re only ‘open‘ to rate cuts even as they have one of the highest rates in Europe at 2%.

3. Why have they been so reticent? They already know that their powers are running out. They were running out when deflation began, and then when the oil shock hit them, what could they do?

4. They can’t even communicate any more. How can the SNB say on Monday “We are convinced that the minimum exchange rate must remain the cornerstone of our monetary policy” and then take this action 3 days later? Even their statement doesn’t sound so sure of the reasons: “While the Swiss franc is still high, the overvaluation has decreased as a whole since the introduction of the minimum exchange rate“. ‘As a whole’? They might as well have said ‘kind of’.

5. Even worse, they compounded the confusion by cutting rates by 50bps down to -0.75% ‘ to ensure that the discontinuation of the minimum exchange rate does not lead to an inappropriate tightening of monetary conditions’. How exactly does -50bps help with offsetting monetary tightening when your currency appreciates by 25% in a day?

6. So they have just made their deflation problem even worse. Which leads to the question of what do they do about that? Which leads us back to point 1. There is very little else that they can do, other than take the pain that economic fundamentals demand.

7. Which is bad enough for Swiss citizens, let alone the fact their central bank just suffered a massive capital loss. Swiss FX reserves are 80% of GDP. Remember their first aborted intervention efforts in 2009 around 1.5000 in EUR/CHF? They were sharply criticised then for failing to prevent the franc from appreciating. It took them another two years to get the political consensus to put in the floor, by which time EUR/CHF was 1.2000. How will the public feel now that they’ve just abandoned that? And exposed them to a massive loss?

8. This kind of unpredictable behaviour has a genuine impact on the economy. How many companies put in place hedges that revolved around 1.2000 being defended because the SNB said they would intervene in “unlimited” amounts? Let alone any issues for banks or fund managers.

To summarise:

Central bank credibility is dead. 

Given that markets have been entirely propped up by central banks since the financial crisis, what’s going to happen when the market wakes up? Is Bobby’s Dream over?

What to expect next:

– Volatility to go up and remain high, although there will be periods where we all think everything is fine. So vol of vol will go up.
– The Swiss Franc is undervalued. Sure, use it as a funder, but now you know that economic fundamentals will get you in the end
– This is a monetary tightening. Stock markets are already spooked by the deflationary forces from a plummeting oil price, so this is unlikely to help stocks
– ECB QE is a done deal, but is it coming too late? Will it be enough now that the cat is out of the bag about the (lack of) effectiveness of unconventional measures?
– Once the general public realise the central banks are impotent, trust in the institutions of government will be even lower, raising concerns about social unrest

For markets:

– Anything the SNB used to buy, has just lost a marginal buyer. So bye bye to Bunds, the Euro and the SEK
– As Marc Faber said at the SG Annual Conference, if you want to short central bank credibility – BUY GOLD
– With vol higher and yields falling, safe havens beat carry – so sell USD/JPY


Waving, not drowning

We thought we had a handle on this oil price fall didn’t we? We thought we could take our time to ruminate on whether it put us in the deflation is good or deflation is bad camp (and there are still arguments on both sides). But markets are all about picking sides, and as usual it looks like we have to run through the panic scenario before we can feel better.

1. We’re worried about oil. Oil just will not rally, trading down again today, currently by -2%. For all those who thought $50 might be some kind of base, this is unnerving.

Oil 13 jan 2015

2. Stock markets are wobbling. Having looked like they had shaken off the poor start to the year, they are retracing. Leaving aside the flash crash in October, we are approaching some key support levels. Here’s the S&P500:



3. Measures of volatility are going up, but they have plenty of room to move higher, here’s the VIX:

Vix 13 Jan


4. FX markets, the most liquid in the world, are still having moments where liquidity disappears. At the end of last year it was the Norwegian Krone, the Rouble and the Polish Zloty, this year it’s the Czech Koruna. This had been sitting quietly for almost a year between 27.40 and 27.80, before spiking to 28.40 in just a few days, as very low inflation data suggests the central bank may need to do something more than just keep a floor at 27.00:


5. Everyone is now looking at the Gold/Oil ratio as a sign of panic, as this has bust up through even its 2008 highs:

Gold to oil ratio

When the main news outlets start producing charts like these, you know there is the sniff of panic in the air.

Usually Blondemoney would remain optimistic, and indeed the big picture result of the oil price fall is another massive stimulus to the consumer and many businesses (note Alcoa reporting strongest results since 2008 due to even cheaper aluminium production). But in the short-term it looks like we need to have a wobble. This week is as good as any, due to relatively second tier data on the economic front, another week to go until big events such as the ECB meeting, and an onslaught of Q4 earnings results from the US.

It may take some time for oil to find a new equilibrium price. Blondemoney reproduces this chart because it is so relevant for how supply/demand could keep oil under pressure until the middle of the year:

Oil demand supply


What the optimist needs is time. Time for more companies to report better earnings; time for inflation expectations to prove they remain anchored (as the NY Fed survey showed yesterday); time for retail sales to improve; time for central banks to say they’re happy to “look through” the oil price fall as “temporary”.

But markets stop for no man, and this evidence is sitting there waiting in our future. Right now, the market looks like it’s drowning, not waving.

In terms of where the position reversals could come… EUR/USD is now out of step with its 2yr rate differential, and we could see a short squeeze back to 1.2000:

EURUSD vs 2yr spread


and so is USD/JPY:

usdjpy vs 2yr

Usually the dollar is bid during a safe haven rally, but the dollar position is now so large that if risk is taken off the table, there should be a dollar sell-off, at least initially. Blondemoney awaits 1.2000 levels on EURUSD and 116 levels on USDJPY to get back into long dollar trades.