FX: How to Trade in a Low Volatility Environment

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Daily FX Market Roundup 06-09-14

FX: How to Trade in a Low Volatility Environment

Should We Expect the Dollar to Rise this Week?

NZD/USD in Play this Week

AUD: Supported by Chinese Trade Data and RRR Decision

CAD: Housing Starts Fall Less than Expected

GBP: Insightful Comments from BoE Policymaker

JPY: Stronger Data Validates BoJ Optimism

FX: How to Trade in a Low Volatility Environment

With the European Central Bank monetary policy announcement and the U.S. non-farm payrolls report behind us, volatility in the foreign exchange market could sink to fresh multi-year lows. EUR/USD’s one-month implied option volatility dropped to a 7 year low last week while the same measure for USD/JPY dropped to a record low. However the decline in volatility is not unique to currencies because the VIX is trading close to an all-time low. Unfortunately the difference here is that most investors are benefiting from the decline in stock market volatility because equities hit record highs but in currencies low volatility has only made trading more difficult. Breakouts have turned into fake outs – a situation that FX traders need to start getting use to. Although the EUR/USD gave up all of its post ECB gains, the lack of market moving Eurozone data this week means that the downside in the euro is limited. Interest rates are at their lower bounds according the Mario Draghi and while “they are not finished” easing, the ECB will want to see how the economy responds to the latest measures before taking additional action. At the same time, a relatively benign non-farm payrolls report on Friday and the lack of uncertainty in U.S. monetary policy will limit the swings in the dollar. Considering that we do not expect any additional surprises from the Fed or the ECB over the next 3 months, EUR/USD will most likely remain within a 1.35 to 1.38 trading range. The range in USD/JPY should be even narrower, with the currency pair likely to be confined between 101 and 103.50. Positive data from Japan will only discourage the Bank of Japan from easing and delay any imminent weakness in the Yen. In a low volatility environment trading, your best bet is to trade the ranges or to trade short-term breakouts driven by economic data. There isn’t much in the way of market moving U.S. or Eurozone data this week but the Reserve Bank of New Zealand’s monetary policy announcement should be a big market mover along with UK and Australian employment reports. However when it comes to trading short-term breakouts or momentum moves, it is important to be nimble – take your profits quickly or trail your stops because the chance of the move becoming a broader trend in a low volatility environment is slim.

Should We Expect the Dollar to Rise this Week?

If U.S. Treasury yields continue to rise, it should only be a matter of time before the U.S. dollar follows suit. So far the gains in the dollar have been limited to the euro and Swiss Franc and in both cases, the moves were not significant enough to take EUR/USD or USD/CHF out of their recent range. The currency pair that should benefit the most from 10-year yields rising to their highest level in nearly a month is USD/JPY but it barely budged on a day when U.S. and Japanese equities also performed well. Having been burned by the Treasury market for most of this year, currency traders are reluctant to believe that the rise in yields will last especially since Friday’s non-farm payrolls report was good but not good enough to accelerate the Federal Reserve’s plans for tightening. We also do not expect much from this week’s economic reports. The only piece of data worth watching is retail sales and unless spending rises or falls by more than 2%, the impact on Fed policy and in turn the greenback will be nominal. However even with the certainty in Fed policy, if 10-year yields break 2.65%, a former resistance level, USD/JPY should hit a 1-month high. In a low volatility environment like the one we are in today, it is extremely important to be tactical. So aside from USD/JPY, we expect the dollar to strengthen against New Zealand’s currency – all other pairs should see more two-way action. A number of Fed officials spoke today but nothing new was said on monetary policy.

NZD/USD in Play this Week

The most important event risk on the calendar this week is the Reserve Bank of New Zealand’s monetary policy announcement. Having raised interest rates at the last 2 meetings, the RBNZ is the world’s most hawkish central bank and 85% of the economists surveyed by Bloomberg expect the central bank to raise rates for the third time in a row. However we believe rates will remain unchanged and this discrepancy is where we see the opportunity to sell the NZD/USD. Since the last monetary policy meeting on April 24th, New Zealand economic data has taken a turn for the worse. Commodity prices have fallen significantly, consumer confidence declined, spending fell, manufacturing activity slowed, the trade surplus narrowed and house price growth slowed. The only area of strength is the service sector and the labor market but unfortunately labor data is for the first quarter and chances are hiring slowed in Q2. The biggest problem for New Zealand is the collapse in dairy prices. Dairy accounts for approximately a third of New Zealand’s exports by value and since February, prices have fallen more than 23%. This prompted Fonterra to lower their payout forecast this year and the expectation for less income should weigh on economic activity. Under this backdrop it will be very difficult for the RBNZ to continue tightening. A pause would not only help the economy but would also drive the New Zealand dollar lower, an ideal outcome for a central bank that threatened to intervene in the foreign exchange market to weaken their currency in April. We expect NZD/USD to fall towards 84 cents ahead of the RBNZ rate decision and to break this key support level, heading to 83 cents if they leave rates unchanged. Meanwhile the Australian dollar received a boost today from stronger Chinese trade data and the government’s decision to promote growth by lowering the Reserve Requirement Ratio.

GBP: Insightful Comments from BoE Policymaker

The British pound ended the day unchanged versus the U.S. dollar and higher against the euro. Last week EUR/GBP dropped to a fresh 1 year low of 0.8065 and if this level is broken, there is no support for the currency pair until 0.7960. No major U.K. economic reports were released today but the Bank of England published its Systemic Risk Survey. According to the report, the main risk to the U.K. economy is an economic downturn but geopolitics and housing also pose a concern. Considering that “the probability of a high impact event has fallen,” we interpret today’s report to mean that the U.K. economy faces less systemic risks. BoE policymaker McCafferty also spoke this afternoon and his comments accurately reflect the central bank’s thinking. They are confident about the recovery, cautious on the housing market and reluctant to raise interest rates. McCafferty said decisions on interest rates are becoming more balanced and there’s scope for further growth before rate rises. In other words, the BoE wants to see growth accelerate further before considering tighter monetary policy. There has been very little volatility in GBP/USD in the recent weeks and unfortunately we are skeptical about the ability of this week’s industrial production and employment reports to take sterling out of its recent range. Industrial production is expected to rebound after falling the previous month but given the drop in the manufacturing PMI index, the increase could fall short of expectations.

JPY: Stronger Data Validates BoJ Optimism

There was very little consistency in the performance of the Japanese Yen today despite relatively positive economic data. GDP growth was revised up to 1.6% from 1.4% in the first quarter. This boosted the annualized quarter on quarter pace of growth to a whopping 6.7%, the highest level since Q3 of 2011. Stronger than expected consumer and business spending contributed to the upward revision although the revision on the latter was far more significant. The current account surplus also rose more than expected, consumer confidence increased and the Eco Watchers survey ticked higher. The Bank of Japan’s forecast that consumers will be resilient despite the sales tax increase is coming to fruition and as long as the data continues to improve, there will be no urgency within the central bank to increase stimulus. This means that anyone banking on USD/JPY rising on a decline in the Japanese Yen will have to wait longer.

Kathy Lien
Managing Director

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