Equities at all-time highs, EUR down for the week

The new normal of low volatility, low trading volumes and equity indices making new highs continued last week with the S&P 500 ending the trading week at 1,900, the DAX closing just a few points shy of 9,800 and the EuroStoxx 50 back above 3,200 points. The complacency of market participants is worrisome, especially when taking into account that the VIX is rapidly approaching its pre-crisis low of circa 9.5% from late 2006. Although previous periods of low volatility have sometimes lasted for two to three years, such as in 2005 and 2006, and the present low vol phase began "only" in 2013, we are now at a point where levels are so low that investors should ask themselves where this is going. Again, a look back tells us that the last time implied vol from equity options was this low the volatility spike and subsequent crash of equities were not far away.

VIX 23/05/2014

This time may well be different, but not in a good way. Central banks all over the world are still pushing their otherwise stalling economies forward, and some, such as the BoJ and the ECB, are even expected to ramp up their supportive efforts. About everybody expects the ECB to cut interest rates and perhaps even introduce a negative deposit rate on June 5. It seems that CBs are still desperately trying to force money into riskier assets, such as equities or the bonds of southern European countries. Therefore, the equity rally is likely not quite over yet. However, the air is getting thinner with each new all-time high. The downside risk has become far greater than the upside potential, in my opinion. Low volatility levels are admittedly not useful for timing the market on a day-to-day basis, but they are a first sign of a stagnating rally. Cautious investors will begin to realize their gains and, if so desired, use a portion of the receipts to purchase ATM call options, which would retain their ability to participate in new highs but significantly reduce their capital at risk. Alternatively, you can always hedge your portfolio using relatively cheap out-of-the-money puts, of course.

Turning now to forex: EURUSD trended further down, as anticipated on May 14. The $1.367 support was effectively broken through on Thursday and the single currency fell further to $1.3629 on Friday. Mario Draghi is apparently still a dominating force when it comes to the dark art of verbal interventions. The EUR will most likely approach $1.36 next week, and from there it could then quickly drop to $1.35 as there are no strong supports in between. A lot will depend on how Germany votes in the European election this Sunday and on any news or rumours that might come out of the ECB or Bundesbank prior to the June 5 meeting of the governing council. This year's ECB Forum on Central Banking, which is held in Portugal from today through Tuesday, is one such event that might produce market-moving remarks from the participants. In the absence of any surprising statements, I prefer EUR short positions at the moment. In any case, expect FX volatility to increase during the upcoming week (before implied vol will no doubt fall back to 5%). Enjoy the ride while it lasts.

New Normal: Strong NFP, weak USD

According to today's NFP release, 288k jobs were added in April, a lot more than the Bloomberg consensus forecast of 218k. In addition, the March number was revised upwards and the unemployment rate declined to 6.3%. Still, USD strength was only temporary with volatile price action immediately after the release and profit-taking in the hour that followed. For example, USDJPY soared up to 103 but quickly fell back to earlier intraday levels in the 102.30/.50 range:

USDJPY Tick Chart 02 May 2014

Decreasing volatility is still a hot topic for USD pairs. After a few swings on Wednesday, EURUSD 1m implied vol is back below the 5% mark, slowly approaching its 2007 low of 4.65%. Central banks, most notably the Fed, have swamped markets with liquidity leading to artificial USD weakness but also purchases of European equities, which arguably continue to support the EUR.

Speaking of equities, the NFP release was also notable because the S&P 500 mini-future <ESA Index> actually fell after traders realized that this was in fact positive news, which, in today's perverted market can only mean negative news for equities. After all, chances are that the Fed will continue tapering if the economy does relatively well. Bad for equities, right? Following this erratic ESA move, prices recovered (see chart), apparently supported by disappointing NY ISM data and a lower-than-expected 1.1% MoM change in new factory orders. As of this writing, however, the SPX is trading relatively unchanged around 1,880, rendering today's data releases a factual non-event. In the meantime, the VIX is slowly approaching the 10% level. Back to (the new?) normal.

ESA Index 30m 02 May 2014