Since EURTRY failed to break through the 50% Fibonacci retracement at 3.9083 on Friday and RSI is back in neutral territory, I closed my EURTRY short trade at 3.9354 this morning. Having opened the position at 4.0524 on 23 January, this translates into a quick 3.64% spot+carry return. I still like the pair for shorts, but considering the sharp TRY recovery since January I'd rather watch from the sidelines until a new selling opportunity presents itself.
Open positions as of 13/02/2017 08:44am CET:
EURUSD short from 1.0795, unrealized return: +1.51%
Realized YTD return: +4.34% from 3 trades
Total YTD return: +5.85% from 4 trades
Volatility implied by one-month at-the-money EURUSD options dropped below the 2007 low of 4.65% today, hitting a new record low just above 4.5%.
FX volatility has decreased continuously over the past three years. Although there was a brief blip after the June 5 meeting of the ECB's governing council, it came as no surprise that implied vol resumed its fall below 5% rather quickly. The continued decline of FX volatility this week contrasts with an increase in the VIX after the S&P 500 bounced off a new all-time high yesterday.
The pronounced period of low volatility is a result of highly accommodative central bank policies in the United States, United Kingdom and Europe, in light of which many analysts sound a note of caution, reminding investors that past periods of such extreme complacency were usually followed by a sharp sell-off. While this may be true, a strong trend reversal can only be triggered by an important event in the market. As long as central banks hold their protecting hands over asset markets, this is unlikely to happen. Markets cannot reliably be timed based on low levels of volatility anyway. Investors afraid of a volatility comeback may therefore prefer to purchase options, which are generally cheaper when implied vol is low, instead of outright exiting the market.
Low levels of implied volatility are supportive of carry trade strategies, because moves in the exchange rate tend to be lower and the risk of FX losses eating up the profits from interest rate differentials are perceived to be lower. We might thus see more interest in trades such as NZDJPY long or EM currencies, especially when taking into account that satisfactory returns are increasingly hard to be found in DM assets, unless you are willing to bear the risk of keeping equity investments despite arguably high valuations. Traders seeking to exploit the interest parity condition via the carry trade must not lose sight of the fact that this is nevertheless a highly speculative bet whereby you are basically "picking up pennies in front of a steamroller", i.e. carry strategies tend to blow up suddenly.