VIX goes for pre-crisis low, watching NZDJPY

Still watching NZDJPY for a possible long trade. The pair is quickly approaching the falling trendline at 83.295 from 2014. In case of a breakout at the monthly close, I'll buy NZD with a first target at 88. The move is currently supported by a broad risk-on sentiment, with the volatility index VIX apparently aiming for its 9.39% pre-crisis low and many equity indices going for their respective all-time highs.

Open positions as of 26/01/2017 11:11am CET:
EURTRY short from 4.0524, unrealized return: -1.97%

Realized YTD return: +0.7% from 2 trades
Total YTD return: -1.27% from 3 trades

January 2015 Nonfarm Payrolls lift USD

Yesterday the U.S. Bureau of Labor Statistics (BLS) reported that total nonfarm payroll employment increased by 257,000 in January 2015 and that the unemployment rate rose to 5.7% from 5.6%. The market had been expecting an NFP release of roughly 228k, according to a Bloomberg survey of economists. In addition, the BLS revised the November 2014 NFP number to 423k from 353k. The preliminary December 2014 revision stands at 329k versus the original release of 252k. That suggests that more than 1 million jobs may have been added in the nonfarm labour market since October of last year, painting a more optimistic picture for the US labour market.

2014 Revisions in Nonfarm Employment
2014 Revisions in Nonfarm Employment (Source: U.S. Bureau of Labor Statistics)

The increase in the unemployment rate may surprise some analysts considering the strong NFP print, but the change may merely have been a result of a disproportionate 0.2% increase in the labour force participation rate (62.9% after 62.7% in December 2014), which is encouraging given that slightly more people are now looking for opportunities in the improving jobs market.

When the number came out at 1:30pm London time, the USDJPY exchange rate jumped almost instantly to Y119 all the way from Y117.2 and EURUSD fell more than one cent to $1.1311 from $1.1459. Currency traders certainly cannot complain about a lack of volatility in the FX market in January and the first days of February. Intraday swings and the return of lasting price trends have provided many trade opportunities for investors. I still expect EURUSD to trade somewhere between parity and $1.1 by the end of the year. The case is similar for USDJPY with the Bank of Japan still set on printing more money to aid its economy. The strong employment numbers from the United States put a possible first Fed rate hike in mid-2015 back on the table.

Macro factors that drove the markets in January

With the first month of the year behind I thought it would be interesting to take a quick look at three major macro themes in the markets at the moment:

Central bank actions -- January 2015 was a month that was dominated by central bank policy actions, most importantly by the ECB which announced a substantial €1,000bn quantitative easing programme on 22 January. However, ECB QE was foreshadowed by the SNB's 15 January decision to abandon the CHF cap, which caused extreme volatility in the foreign exchange market. The SNB apparently did not think it would be able to defend the EURCHF floor once the ECB would begin pumping euros into the economy. The ECB announcement was followed by Denmark's central bank to cut interest rates further into negative territory twice within two weeks. This was to be expected given that the DKK is also pegged to the EUR. Additional central bank actions were seen in Canada and Russia. Central banks were the predominant influence on the markets in 2014 and that is unlikely to change in 2015.

EURUSD January 2015 Chart

Increase in volatility -- Market participants had various negative macro drivers to worry about in January, most notably the drop in commodities prices, political uncertainties and (still) the state of the world economies. Implied volatility in equities, as measured by the VIX index, increased accordingly. The VIX shows first signs of an upward trend that may have started in the fourth quarter of 2014. The expected tightening of Fed monetary policy is certainly one factor behind the increase in volatility, but political frictions with Russia and the recent elections in Greece also weigh on investors' sentiment. Risk-off was a definite theme of January 2015. It also shows in the price of gold and capital flows into other safe haven assets.

01/02/2015 VIX Index Daily Chart

Divergent performance in equities -- However, the performance of national equity indices was more idiosyncratic, as demonstrated by the chart below. While the US stock market struggled somewhat in January, both the DAX and the EuroStoxx50 posted significant gains. Market participants begin to see the strong US dollar as a problem for US exports. In addition, the low price of oil hurts America's oil industry (US oil production is almost at an all-time high), although it certainly lifts a burden off consumers' wallets. As can be seen, European equities were helped particularly by the announcement of ECB QE on 22 January: The DAX has since established a plateau above 10,500 points while the SX5E has stayed above 3,300 points. The Athens Stock Exchange, on the other hand, gave up all of its gains in the last week of January in anticipation of and reaction to Syriza's election victory, which is a major source of uncertainty for the country's economy and the euro zone as a whole. The ASE ended the month at a low of 721.93.

January 2015 Stock Indices Performance Chart

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