Friday, April 20, 2007
Have you got your bottle of champagne of ice? Or, if you live in the United States, your bottle of California sparkling wine, since true champagne is now unaffordable. This morning EUR/USD has traded up to 1.3638, a scant 32 pips away from matching its all time (post euro launch) high. With such an obvious target so close, a new all time high could literally come at any minute.
Aussie through 0.80, cable through the deuce, and a new all-time high in EUR/USD. What more could you want to signal a dollar crisis? Heck, even The Economist has had the decency to keep the dollar off its front cover, thereby permitting further downside. A funny thing happened on the way to the currency crisis, however. If the dollar really is in the process of crashing, it seems to be happening in high definition, super slow-motion. And if it’s happening in super slow-mo, can we really characterize it as a “crash” or a “crisis”?
How can we define a crash or crisis? Well, a reasonable shorthand definition, it seems to Macro Man, is the attainment of a new price extreme accompanied by a large rate of change (say, over a three month period) and high/rising volatility. And by this measure, the recent spate of dollar weakness (against the euro) bears little resemblance to episodes in the recent past.
EUR/USD has only rallied about 5% over the last three months, which is hardly a signal of impending Armageddon. In the good old days, that could have been a daily range! At the same time, implied volatility has barely moved, remaining close to all time lows. And with good reason- realized vol has also been remarkably low! So while the dollar has weakened fairly steadily, there is absolutely nothing to suggest in the currency episode that global investors are panicking or fleeing the dollar wholesale.
The last two episodes of dollar weakness, on the other hand, tell a different story. In late 2004 the dollar’s three month rate of change comfortably exceeded 10%, one month implied vols traded around 10% (in contrast to the current 5.8%), and there was a sharp uptick in realized volatility.
Similarly, when EUR/USD breached 1.20 for the first time in late 2003 and traded as high as 1.29 in early 2004, there was considerably more sound and fury than we currently observe. The three month rate of change reached 10% (twice!), one month implieds traded comfortably above 10%, and one month realized vol moved substantially as well…
Whatever the reason, the lack of volatility in the current bout of dollar weakness suggests that doomcasts of a US financial market implosion on the basis the dollar remain well wide of the mark. If foreign investors really were preparing to ditch US assets wholesale, surely we’d expect the currency market to exhibit more thunder and lightning than is currently the case.