FX Update: New record lows in FX options implied volatility, but...

Forex 5 minutes to read

John Hardy

Head of FX Strategy

Summary:  US treasuries are firm in the wake of a weak US CPI print yesterday and may continue to drive JPY resilience and then some if equity markets consolidate as well. The US-China trade deal signing may not see the release of the full text of the deal, but could we still see a sell-the-fact reaction in risk assets? Meanwhile, FX traders are dealing with a market that expects record low volatility out over the horizon.


Today will see the signing of the US-China trade deal in a ceremony at the White House, with President Trump affixing his signature to the deal, while his Chinese counterpart Xi Jinping won’t. While some purported details of the deal have emerged, we may not know the full extent of what has been agreed, in part because China has expressed an interest in keeping the deal unwritten (to save face in the event the volatile President Trump throws a fit and tears up the deal at the least provocation and/or to avoid the obvious fact that many of the details that have emerged are in direct violation of WTO rules?)

Markets were spooked at various times yesterday by two developments, first the story that existing US tariffs on Chinese goods would remain until after the US election (how convenient for Trump and gives him bragging points in his election campaign – the offsetting positive spin being that China is signing the deal after all?) and second, earlier in the day a BlackRock letter to CEO’s in which the influential, world’s largest investment manager, with over $7 trillion under management, claimed that the climate agenda would become increasingly influential on all levels of investment allocation, with enormous consequences. See our Steen Jakobsen for more on this, as well as our Equity Strategist’s list of green stocks that could enjoy considerable attention on this theme in coming years. We have already penned our Q1 outlook, which will be out shortly, and it has a climate focus as well.

FX implied volatility has reached new record lows for the cycle as we note in the Deutsche Bank 3—month implied volatility index heading south of an incredibly low 5% for the first time and see USDJPY 1-year volatility trading at a record low sub-6.25%. We’re entirely unsure when volatility will return, but a very low volatility levels on the 1-year horizon look very attractive for a pair like USDJPY, given that a US election is taking place in less than 10 months and could spell tremendous volatility should Trump fail to get re-elected. Something to consider. Our operating assumption is that downside risk is greater in a non-Trump, US in or near recession scenario.

In the meantime, we are curious whether markets have over-celebrated  the central bank liquidity provision theme and whether we are set for a bout of market consolidation – potentially on a sell-the-fact reaction to today’s US-China trade deal signing.

Chart: USDCAD
Very low volatility in most USD pairs, but we focus now on further upside potential for USDCAD on the risk that the market has the Bank of Canada rate outlook wrong (too high) and that CAD has more room for downside via mean reversion relative to other USD pairs and on positioning as CAD is one of the few currencies the market is long of versus the US dollar. A close clearly of 1.3150 could set in motion further potential higher toward 1.3500.

Source: Saxo Group

The G-10 rundown

USD – the USD remains firm but lacks a pulse tactically as we await whether the US-China trade deal sparks any interest.

EUR – the EURUSD suffered a bearish reversal, but has yet to follow through lower, even if the chart is tactically bearish as long as we remain below the 1.1150-75 area.

JPY – US yields ticked down yesterday on a weak CPI release – expect any further strength to drive JPY resilience, especially if a bit of equity market consolidation is thrown into the mix. Alternatively, consider CADJPY and NZDJPY downside.

GBP – sterling was putting up a bit of a fight after poking at key levels in EURGBP near 0.8600, but still skeptical that it can mount any pronounced rally unless we see a breakthrough in this very early stage of EU-UK trade deal negotiations, especially after a very weak December UK CPI print (cycle low since 2016 at 1.4% year on year vs 1.7% expected) and as the market firms its view of an imminent BoE rate cut.

CHF – EURCHF rushing to new lows for the cycle yesterday as the US has recently placed Switzerland back on its watchlist of currency manipulators, suggesting that SNB has little room to operate against CHF appreciation and the natural background pressure is on the CHF to strengthen, given Switzerland’s current account surplus expanding back to an incredible 10% of GDP after dipping below 7% in early 2018. This could prove one of the few trades going at the moment if CHF is rerated lower here to 1.0500 or even lower.

AUD – AUD struggling against the US dollar again – but has gone nowhere since pumping into year-end and then dumping to start the year. One place to consider AUD resilience is in the crosses like AUDNZD and AUDCAD on the angle that the terrible bushfires will trigger a fiscal stimulus and insurance-related flows.

CAD – the Loonie one of the “safer” areas to trade USD strength as there is more room in positioning and mean reversion terms and the Canadian rate outlook remains unrealistic in our view.

NZD – AUDNZD has posted a bullish reversal, now it is about follow through higher, which may require a negative NZD catalyst, though we also eye the 0.6600 area in NZDUSD and whether a break encourages additional flow as longs run for cover.

SEK – the ex energy Swedish December CPI number a bit soft this morning as we awaiting an economic upswell in the EU and/or fiscal stimulus there and/or in Sweden for a more profound SEK-positive catalyst.

NOK – three weeks of very compressed volatility after the market front-ran the end of year weak NOK seasonality – NOK needs fundamental support from a more pronounced upswing in the global growth outlook plus another bump in the oil and gas (natural gas exports as import for Norway as oil in recent years and will become more important in the years ahead).

Upcoming Economic Calendar Highlights (all times GMT)

  • 1000 – Euro Zone Nov. Industrial Production
  • 1330 – US Jan. Empire Manufacturing
  • 1400 – Canada Dec. Existing Home Sales
  • 1530 – US Weekly DoE Crude Oil and Product Inventories
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