The simple answer is often the best answer

We’ve been scratching our heads a bit in our trading room over the bond moves (and others) in recent days. Is it falling Central bank expectations, or fearing a top in inflation, problems over the next US stimulus package etc etc? There’s lots of very valid reasons why we’re seeing these moves but there’s also lots of doubt.

What’s puzzling me is the speed and acceleration of these moves, and why FX isn’t joining in. US 10’s going from 1.64% to 1.43% in 5 trading days, while USDJPY does nothing in a 50 pip range does not compute at any time, especially when they’ve been in virtual lockstep all year.

I think these moves being touted as an unwind of Fed/other CB’s/inflation expectations are a bi-product of all these other moves, rather than a true reflection of a change of those expectations. The market has been front-running the Fed getting it’s arse bitten by inflation all year, even through Powell and all the transitory calls it has endured, so now it’s actually got the data to back it up, why on earth would it be throwing in the towel, in the space of 5 days?

What is the reason then?

For a while some of our traders have been noting strength in currencies like ZAR and MXN (you’ll have seen Kman trading in and out of it previously), and now we’re seeing a pick in buying in others, (see TRY today). What do they have in common? Yield.

We’re seeing volatility collapsing (EURUSD & USDJPY sub-5% in 1m ATMs, GBPUSD sub-6%) and if the market doesn’t think it’s getting any major central bank action until late Summer/Autumn, then there’s even less volatility risk, so why not park up in something safe with a bit of tick-over yield, or something with high yield in a low vol environment (Turkey interest rate 19%, Mexico 4%, South Africa 3.5%) for a few months and go on holiday. The low vol is affecting markets everywhere. Look at what we’ve been citing in AUDUSD and the options there.

What does this all mean for FX?

Not good news unfortunately. Unless you want to take part in the carry trade and sit in some high yielders for a while, I fear we’re going to be seeing a lot more of these tight ranges and quiet days. This is something I’ve been expecting for some months while we wait and see how economies recover from the virus but I didn’t think vol would be taking such a quick nose dive like this. That’s not to say we won’t see any moves but they might be few and far between. There is plenty of other things going on in the world (Geopolitics) but even governments will be heading off for summer breaks soon. All we can really do is plot our levels and exercise patience. We need to try and hold back from chasing our levels, and make sure we take some profit while it’s there, even if it’s for 5/10/15 pips. Quiet markets can be just as dangerous as volatile markets because it can lull you into a false sense of security. See a 40 pip move in a price that’s spent 4 hours moving 10 pips, take the profit if you have it in case it then reverses and goes back to the snooze fest.

Be aware that if this is just a “transitory” (😉) situation for the summer period, have your eye on the calendar in readiness for when markets do decide to reverse out these summer plays to get back into prior positioning. If you can catch some wider range edge moves that will put you on the right side for that happening in a few months, it might be worth sliding into small positions to sit on.

There will always be opportunities, ebbs and flows in volatility and our job as traders to adjust to the conditions in front of us, while also keeping one eye on what the future may hold too.

“Sell in May, and go away” used to be a well known phrase but it’s been many many years since we’ve had a market do that. We may just be seeing that now.

Ryan Littlestone
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