Where’s the action?

Watching the Dow Jones’ tepid flirtations with the 20,000 level has quickly become pretty dull. After almost two weeks of coy approaches, many traders will have been tempted to switch over to the red-hot action in the FX market. We’ve been getting some very decent moves so far in 2017. USDJPY has seen low-to-high ranges of greater than 1% on six out of nine trading days this year; for the EURUSD it’s been five out of nine days. Impressive stuff.

Given these moves, it’s no surprise that option market participants are betting on continued action in FX-land while expecting the major indices to be tranquil. This has led to a pretty rare state of affairs where FX vol is at the upper end of its recent range and equity vol is at the lows.

To get a sense of just how unusual this is, I’ve looked at 3-month ATM vol in the two FX pairs and the VIX since the start of 2014 – thereby missing out the higher volatility regimes associated with the Eurozone crisis and the first year or so of Abenomics. Mid-December last year was the only time we had volatility in EURUSD and USDJPY in the top 20% of observations while the VIX was in the lowest 20%. Another way of looking at it, 3-month implied volatility in USDJPY has only closed higher than the VIX on just over 5% of trading days since the start of 2014. Almost half of those instances have been since the US election.

Thinking through what Trump might mean for the two markets, there’s some logic to it. After years of investors favouring defensive stocks at the expense of cyclicals, the Trump reflation trade in equity markets could well have further to run. As we’ve seen over the past month or so, this repositioning acts as a kind of stabilizer -- the major indices don’t move very much, while money moves aggressively between sectors.

Meanwhile, there’s less reason to expect such stability in FX, where the market is very focussed on the prospect of more pronounced policy divergence between the Fed, the ECB and the BoJ. 

For a Trump sceptic, it’s very tempting to bet on this divergence closing. It’s hard to believe that his reshaping of international relations and policy-by-tweet won’t lead to higher equity volatility. And if you don’t think he can deliver on his tax and spending promises, it’s unlikely that we get the pick-up in US growth expectations needed to move the dollar from here.

Still, I wouldn’t be rushing to sell FX vol and buy the VIX just yet. Given the FX moves we’ve seen so far this year, currency vol actually seems reasonably valued. And while the VIX looks too low, the steep futures curve makes it costly to hold.

This could be one of those disconnects that persists for much longer than anyone would expect. 

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johno
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January 13, 2017 at 5:27 PM ×

Nice piece, Macronick. Thank you!

Interesting moment for the market here. Dow=20,000 overheard. A lot of resistance it seems. And then JPM just turned down on the day despite beating estimates. Not a great setup for the longs. We'll see ...

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Nico G
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January 13, 2017 at 5:51 PM ×

abee

it's just the 1,2,3 step program that was worth mentioning, i remember the market shot up the day the war started, which was not exactly intuitive to the layman, and i guess that was Jared's point. Between 2000-2003 bear market and 2009-2017 bull market we agree trends are opposite so expect 1,2,3 programs to be opposite too

1 - limit down at election result
2 - Trump trade into inauguration
3 - Imagination is over, reality begins

i apologise for Jared's lame 'buy the rumor sell the news' subject but it does work all the time, see JPM earnings today

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Nico G
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January 13, 2017 at 6:09 PM ×

on a VIX note i agree with Macronick did you see how Rex Tillerson pissed off China in his hearing yesterday? "‘Prepare for a Military Clash’" replies China today. Those are not kids at the playground, we're talking about the two biggest economies in the world going full collision mode

Russia is leaving the G8. There is a lot of (re)allignment at play personally it is a fascinating new era for any history buff and i doubt it will keep VIX so compressed for much longer. The steep term structure was mentioned so buying the most distant expiry that stil has two bits of liquidity would be the way to go here

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IPA
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January 13, 2017 at 6:34 PM ×

Second that, Nico. Pretty scary times indeed. And agree on far-dated puts as a better way to short the near-term fantasy land. I am not touching anything pre-May (by then DJT's 100 days are over) and on some positions have acquired leaps at silly bids. It's so cheap right now it's not even funny. On some occasions I felt like I was trading against myself. Simply dead action. So Macronick definitely has a point here in the near term.

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Nico G
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January 13, 2017 at 7:13 PM ×

Trump needs to start trusting and working with US intelligence he needs to get his guys there fast. His last clash with intelligence regarding the despicable piss affair is worrying the CIA is showing no respect.

Trump adversaries understand he is fighting the Deep state hence he WILL be tested straight away by the big boys (China, Russia, then Iran Turkey etc) to see if his actions are where his big mouth is and more importantly, whether US intelligence will back him up. It is a deep conviction that looking back, January 2017 record low level of VIX will look like an aberration

you can read maximum uncertainty at http://policyuncertainty.com/ which when paired with record low VIX paints a very uncomfortable picture

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Skr
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January 13, 2017 at 8:27 PM ×

Macronick- one would think the way to play the above - is to keep it tight and scalp it for 1-3 %

Struggling to find anything of macro interest 6-12 months from here.

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johno
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January 13, 2017 at 10:41 PM ×

Hey Nico,

I should probably be dedicating more attention to FX these days (just have -EURNOK, -EURSEK, +EURGBP), where the action has been as Macronick points out, but I have positioned with very short-dated options for a selloff into the inauguration. So many people must be thinking the inauguration will be a sell-the-news event and with Dow=20,000 providing such formidable resistance, not to mention momentum having subsided (the 21-day MA is now flat), why would they wait for the 20th to sell?
I figure if we go through 20,000, the move could be extended, so I like that my option position's delta falls away quickly in that scenario (but keeps me involved in case it's a quick headfake). I've also looked at some elections where there have been high hopes, like Modi, Duterte, Kuczynski, and the markets rallied well past the inaugurations in those cases. I don't want to be hanging onto a position for months that's moving against me ... uses up too much energy I could use to make money elsewhere. IPA's idea of longer-dated options is interesting, though the vol curve is so steep (summer VIX trades with an 18-handle), I think I'd rather just not be involved beyond the very near-term, and wait ... I can always short in May or buy puts then (probably with VIX less than 18 and without paying the theta in the meantime).

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washedup
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January 14, 2017 at 12:56 AM ×

@Nico - its very hard to agree with that buy the election sell the inauguration nonsense - if only it were that simple - there is zero doubt in my mind this market is flying into the Sun and asking for it, but impossible to forecast timing that precisely - frankly a lot of the trump narrative is just a way to explain the rally which coincidentally caught the market short overnight into election day, then the dollar rally got macro guys long US cyclicals and finally the momo types piled on as they usually do. I think people looking for a selloff starting Jan 20 are about to be sorely disappointed (funnily, so may the folks looking for a further rally). I do know your horizon is longer so it'll work out in the end.

Something changed in this market post Feb 16 after CB's met in Shanghai wearing brown pants and holding their noses, - I think Abee even posted something about a stealth Shanghai accord back then - we entered a new regime right after where volatility gets crushed over long periods of basically un-forecastable duration, and then appears in a spike over short windows to right the average somewhat. I hate to forward it as a theory, but I do think the ECB bond buys that started in Feb-March may be responsible in an indirect way - I also think you may have the implications of the Italian stuff all wrong - the more Europe looks like a basket case without it being serious enough to kill the goose, the more leeway Draghi gets to eat junky crap and keep bulls happy - inflation in Germany may be the only thing that can change that dynamic, and that will take time. Something messy in China may be the other thing, but we've been waiting for a while and they don't seem to have a problem keeping the morphine drip going either, because what choice do they have?

It's inflation - we get it in a manner thats sustainable and self fulfilling, its game over for risky assets - even then equities will initially use that as a bullish excuse (as they have already), till they go asking for the next hit and get greeted with a frying pan, but that will take a while won't it?I guess It would be nice if the market was max long bonds instead of short - would hasten the process.

Good luck with your positioning - ur one of the best.

Thanks for the articles by Macronick, LB, and Abee - I am really happy we are keeping the show going!

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abee crombie
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January 14, 2017 at 11:45 AM ×

Washed i couldnt have said it better. Economy is cyclicaly strong here, in europe and asia especially and that started before trump. While i dont think it lasts forever or we have entered a new regime, seems likley to last for at least another quarter if not all year. Slow down in dollar appreciation and upward move in rates only feeds in to extend this party.

Im not a raging bull and heck maybe sell in may works like a charm but im looking to throw in towel on short trade, at least until i see something.

On the long side health care, staples and anything defensive deserve a look, not as a sector trade but individual companies.dispersion is high in these sectors now. Biotech looking interesting, along with some good global franchises like AIA.

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Anonymous
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January 14, 2017 at 11:47 AM ×

washedup is correct regarding the 'Shanghai Accord'. I work for a central bank, and can confirm that indeed such a resolution was decided. I think most major banks and other market participants now understand that risk assets are being supported to help meet monetary and other targets. Furthermore people understand that it is indeed beneficial to do so. We have an aging demographic in the Western world, and global debt levels that warrant such policy action. Frankly to let risk assets crash would be irresponsible.

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IPA
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January 14, 2017 at 4:13 PM ×

My posts disappear now and then. Has it ever happened to anyone else here before? I wrote the same thing (copy below), obviously with no expletives or demeaning remarks, to find out my post is wiped clean hours later. Perhaps gremlins reside here, or the invisible ink is being used in this thread, or big bro is simply annoyed with me (err... technical glitch), nonetheless here is what I said earlier:

johno,

I trade weekly and monthly charts. I can't be bothered by near-term options and all the noise that comes with that. I am looking for a large VIX move and would like to be out when it's above 30. I can't wait until May and want to be short now. Have been busy buying puts all this week but still have plenty of dry powder left to put to work.

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checkmate
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January 15, 2017 at 11:01 AM ×

"The chancellor, Philip Hammond, has suggested Britain could transform its economic model into that of a corporate tax haven if the EU fails to provide it with an agreement on market access after Brexit."

OK, I might have been slipping him team plays from the sidelines.

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Bruce in Tennessee
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January 15, 2017 at 1:48 PM ×

"Furthermore people understand that it is indeed beneficial to do so. We have an aging demographic in the Western world, and global debt levels that warrant such policy action."

..Whoa! Couldn't pass on this...you have certainly been drinking from some fountain of kool-aid. Trump was elected because a great many in America see this as wrong-headed thinking. You think just because you work for a central bank that "global debt levels" are beneficial to the working man (?), or perhaps beneficial to you as central banker-speak. This harms the youngest working sector, decreases productivity as the debt always has to be addressed, and is "fake" economics.

...The whole recovery meme is built on debt...the question is how to address it so that society regains normalcy...



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Anonymous
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January 15, 2017 at 3:24 PM ×

Not anon from 11:47, but

"Trump was elected because a great many in America see this as wrong-headed thinking. "

Are you seriously suggesting that the average Trump voter (or any average voter for that matter) considers fed (or any) central bank policy towards global debt levels when pulling the lever ?

Trump got in on nationalism/protectist/bring back blue collar jobs/fuck the establishment/elites sentiment. That post Trump breakout ? Cheered on by many supporters online as MAGA in progress.

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Anonymous
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January 15, 2017 at 3:31 PM ×

The way to deal with Trump is to watch him speak and not read the transcripts. He sounds a lot softer than reads...more conversational, off-the-record like. Ignore the hype. He is all over the place, using unpredictability and tough rhetoric to cover his weaknesses (mainly that he's incompetent and totally at the mercy of his advisors). He's falling over himself flattering everybody he thinks he might need in the future, but also reminding others not to cross him or else...and watch American business fall in line. It's all a big reality show. Macroeconomic effects will be negligible. China will throw him something which he'll make a big deal out of, and things don't really change.

Trump isn't a fool. He tried his damnest to lose the election, but thanks to Putin leaning on the scale he won. He knows his limits, but because he's a narcissist, he likes the attention and is equipped with the ability and willingness to manipulate and extort others to do his bidding. This guy values loyalty above everything, because he's vulnerable.

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Anonymous
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January 15, 2017 at 3:46 PM ×

Also, fade any scandal that doesn't involve a videotape of him molesting a child or ******* an animal. If there was anything like that, it would probably be in Putin's pocket, and he'd be the second to last guy to release it. Sex orgies...give me a break. The leaked memo is a boon to Trump because it looks like bad smear job with no evidence and now he can write off whole segments of media as conspirators working against him out of malice. The worse the next accusation sounds, the less credible and better for him it is.

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IPA
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January 15, 2017 at 5:35 PM ×

I was wrong on my last copper trade and moved aside. Live to fight another day, be disciplined, use stops (mental or hard) or get out of this game before you are in financial peril.

I get the reasons why the quick rebound happened last week but I can play the devil's advocate on all of them (perfect storm my rear end). Possible largest Chilean mine workers strike is looming (an agreement could be reached soon), Indonesia threw confusing export rules monkey wrench into the mix (they were already backtracking yesterday by issuing clarification and saying how it's going to be mostly neutral to the output), LME stocks steadily declined (still elevated above the normal levels indicative of healthy demand), China is going to buy infinitely more copper (one monthly rebound in copper imports does not a trend make), and construction of DJT's Mexican Great Wall and bridges to nowhere is about to commence (yeah right, back to debating the authenticity of the sex tape).

Specs are delirious, once again heftily increasing their net long positions. To the Moon, Alice! Then why are the producers so eagerly shorting this recent pop and are at their fourth largest weekly net short position in 10 years? I will go with them as their decisive COT positioning on the opposite side of specs is always a precursor of big turns in price.

Weekly copper chart is now looking like daily did when it double topped at $2.75 when price made a slightly higher high on a lower high in momentum (i.e. divergence). I still think copper will reverse and head lower. I will short it again on two daily consecutive closes below $2.60

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AW
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January 16, 2017 at 3:55 AM ×

3m and 6m Equity Index vol looking too cheap to ignore.
I have been buying 95% 3mth Puts to bottom drawer. ASX due to home bias.

Also own some USDJPY 111.0 Puts a few mths out, to see if that wants to let go.

Just be long gamma in this mkt I think.
Per the above, FX certainly paying you for that right now.

Was short a few EURUSD downside puts over xmas/NYE and was rewarded with a 300pt range over that 'quiet' week. Short gamma nightmares.

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Rossco
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January 16, 2017 at 6:07 AM ×

@IPA , appreciate your thoughts on copper.

What is it about the weekly chart that makes you concerned ?

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Anonymous
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January 16, 2017 at 6:28 AM ×

"He tried his damnest to lose the election"

Looking at Trump's rally schedule during the last week of his campaign (3-4 rallies in 1 day ?!). Not only that - he campaigned the heaviest right in Hillary's blue wall right till the end and successfully stole her crown jewels.

Trying to lose ? If thats the case I would like to see what he can do if he tried to win.

Russian Hacks ? You think DNC email scandals were more effective then his promises of restricting immigration/bringing blue collar jobs back to the blue states that he flipped ?

Come on.

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checkmate
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January 16, 2017 at 8:03 AM ×

In the first of the EU 2017 elections the Dutch look set to make a complete pigs ear of it with the anti EU vote getting the most seats ,but not enough to form a govt whilst the rest appear to be an umanageable coalition. Looks like the protest vote wins again albeit the likely outcome being no govt at all. Perhaps they should try an EU referendum? Sorry , forgot they already did that back in 2005 in a sense ,but as usual in that period politicians felt comfortable in rejecting the voters will when the result did not meet the politicians desires. When one considers how Democracy as been hijacked in Europe by political pole climbers the only wonder is that it took so long to arrive at a point where voters are basically rejecting career politicians.

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Nico G
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January 16, 2017 at 9:14 AM ×

johno - as you know market does its best to catch everyone off course and inflict max pain. I understand max pain those days the way of the torturous time decay. the only safe way to arm a short would be 3/4 month put spreads, or outright puts that are at least 20% otm but most retail speculators lose on options thus the game is not geared for them. That would answer folks here who advocated the use of options vs. the folly of futures. I personally stick to futures and can sleep at night with an adverse mark to market as long as time decay is contained (you just have to 'pay' dividends and potential tax credit, which is particularly acute the second cycle of Estoxx)

washed - let's see what happens i frankly do not see a Dow 20000 market breathe in relief on inauguration day that Trump is all reasonable, all predictable and market friendly so that we can ramp another 5% higher. Best case scenario market does nothing, but i am positioned for a new reality of ??? and !!! that hits the fan real hard

as for Italy you should talk to personal friends who are long only and count(ed) among the best asset managers of the country. I repeatedly disagreed with them on Italian banks which they owned in size and they have lost a fortune while i held the opposite position via Estoxx futures (until last summer). If you think that situation makes Draghi happy, it has inflicted horrid losses on 'conservative' 'small' people and even folks who bought MPS junior bonds thinking it was safe. Draghi ain't helping them. Cf. Greek banks where anyone who actually tried to envisage a bottom got taken to the cleaner. You claim that i may have the implications of the Italian stuff all wrong but so far i traded the Italian stuff successfully and since we are not writing academic books here that is all that matters right?

you are right when it comes to inflation as the last judgement for risky assets worldwide. The big decider is 2.60% on the 10Y it can really be used at the threshold between the 'same old' new normal and the brutal return of the old old normal

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Anonymous
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January 16, 2017 at 10:37 AM ×

Bill Gross sounded definitive on 10 year levels in his latest monthly update.

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Nico G
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January 16, 2017 at 11:09 AM ×

check that beauty! https://www.youtube.com/watch?v=Fgw1NNMlVxk

Trump a month before October crash, 3 years before the first Gulf war, when Japan was China (the bad guy). Gotta admire the trademark confidence displayed at 41 years old, blasting Japan, mayor Ed Koch and NATO. And a rarely seen social conscience. Trump was right on the next presidency being one term with Georges Bush senior

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Anonymous
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January 16, 2017 at 1:23 PM ×

Chinese speculators rotating form growth to "value".

SSE Composite Index -0,3% overnight while SZSE COMPOSITE INDEX -3,62% and CHINEXT -3,64%.

Chinese markets haven´t been moving much lately, might this be changing?

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Unknown
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January 16, 2017 at 2:01 PM ×

It used to be "sell in May" but now for GBP it's "sell when May speaks"

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washedup
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January 16, 2017 at 2:04 PM ×

@anon 1:23 - more like rotating from a steaming pile of garbage to a vat full of effluents!

I don't think there has been such a thing as a chinese 'market' since fall 2015 - I wouldn't expect anything big except for 5 minutes while the operator of the buy joystick takes a bathroom break.

@Nico interesting link - clearly trump's mercantilist lean was a long time in the making, and all we've done is replace Japan with China in his mind. I have to say some valid points regarding the Saudis.

The irony of a mercantilist approach in the approaching age of automation is that robots don't have a country you can blame, neither do they have any interest in consuming the products one makes, tariffed or otherwise!

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IPA
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January 16, 2017 at 4:51 PM ×

If the price makes a higher high in the next few days it would be on a lower high on momentum indicators. We'll see how the price reacts. My guess it's a quick rejection and a reversal.

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