FX Update: Again, our crystal ball eyes a return of FX vol down the road
Head of FX Strategy
Summary: Another indecisive session yesterday has the volatility sellers jumping for joy, but a look down the road at the implications for the likely policy mix still has us believing in a strong comeback for FX volatility, possibly soon, but certainly not long after the US election. For now, sterling perhaps has the most ability to move if Brexit negotiations see notable breakthroughs next week.
Yesterday offered another object lesson in this market’s inability to find direction, as a curious little ramping in EURUSD intraday toward the 1.1300 handle and a tempting break to a new 1-week high was quickly batted back lower, leaving EURUSD showing five consecutive days of near “doji” indecisiveness- classic! And given today’s holiday in the US, we may make it six days of extending the USD limbo. At present, the only currency with a proper “known unknown” on the immediate horizon is sterling, where it looks as if the Brexit talks are proceeding reasonably well, especially as the EU’s stance on the jurisdiction of the European court of Justice seems to be softening. The purest expression of GBP prospects are in EURGBP where we continue to eye the 0.9000 as a pivotal one as per Wednesday’s FX Update (also referenced below).
As I have noted, FX traders are finding it difficult to scratch around for a driver outside of a reflexive reaction to “risk on and risk off” developments in a world that lacks any ability for bond yield spreads to shift almost no matter how good or bad the data because all policy rates are at more or less absolute zero and yields farther out the curve are failing to show volatility, either because central banks are actually intervening with QE or because of the assumption of eventual yield-curve-control.
Ironically, it could be that very “control” from policymakers that eventually makes currencies a more volatile asset class, and argument we laid out yesterday and one that could kick in once the primacy of fiscal policy becomes absolute and if real interest rates become the focus in a world of resurgent inflation. As noted yesterday, Hungary could be a test case for this narrative, given where its current account has shifted to and a populist government and the risk of being, not to mention where its real rates were headed before this crisis, with a deposit rate of 0% and inflation running hot over 4%.
Imagine a future, therefore, perhaps not so far down the road and as early as next year, when we start to develop an intensifying focus on CPI readings, the comparative scale of de facto debt monetization, etc., as one that could drive increasing volatility in hard asset prices, particularly gold and silver and relative move in FX, as countries will inevitably choose different degrees of aggressiveness on running negative real rates – a basic necessity from nearly every government’s perspective here in order to devalue the real load of debt, and, arguable, reduce inequality with the accompanying destruction in the real value of assets and savings.
An additional wild card, which we will discuss intensively no doubt in the coming (precisely) four months, will be thoughts on how policy post the US presidential election will shape the USD, real rates, the US current account, and investment flows. The latter has becoming a more urgent issue with the advent of the Hong Kong security law, which may accelerate the US-China disengagement if the US responds aggressively. Whether the Democrats achieve not only the presidency, but a clean sweep of the Senate is a key factor for how powerful the possible shift away from the Trump era proves. At the moment, the PredictIt odds are 61/39 in favor of Biden over Trump and 62/38 in favor of the Democrats taking the Senate, which would be a Democratic clean sweep, the only way to get broad new legislation passed in this era of total partisan division.
After the 2016 election, everyone lambasted the pollsters for getting the election prediction wrong, probably partially deserved, but the aggregate national polls weren’t that far off the mark, with national polls in the six months prior to the election moving back and forth but generally tightening in Trump’s favour into Election Day, at which he lagged Clinton generally well over 3% in the polls, with the final results a shortfall of only -2.1% (reminder, yes Trump lost the popular vote nationally in 2016 by almost 3 million votes but won the election by taking a majority of electoral votes). Over the final six months of polling in 2016, Trump sometimes lagged as much as 6-7%. For this cycle, with four months to go, he currently lags over 9%. In short, It looks like very low odds for Trump without some new catalyst
For now, let’s what a three-day holiday and Independence Day celebrations in the midst of a pandemic and a rather volatile US political and societal environment bring us. For my part, I will be taking next week off – returning July 13.