FX market turnover today and month-to-date in October has been painfully low. We highlight as many as four factors which are currently suppressing market volatility and positioning including: uncertainty over the Fed’s ‘no taper’ in September and a possible messy exit in the future, regulatory hurdles on both sides of the Atlantic, the political impasse and fiscal crisis in the US, and the uncompleted cross-border investigations into FX rate manipulation around the fixings. None of these factors will, we believe, dissipate quickly.
This volatility suppression suggests that, at the end of the day, what goes on in the political is by far the most important of factors. At times it would even appear, as it does now, that the suppression of volatility can be instigated or assisted by central banks. Crushed volatility goes a long way in allowing politicians to make their painfully slow decisions inside of a vacuum, with few if any market pressures which can force them to move rapidly. Effectively, suppressed volatility makes the passage of time a less important factor.
If we are judging outcomes solely on the basis of the DXY’s correlation with ‘risk’, describing 2013 so far as a ‘false dawn’ for the USD would not appear to be all that far from the truth (Chart 1.). What the correlation shows us is that we are approaching ranges between -1.0 and 0.0 which are firmly entrenched within ‘classic risk-on/risk-off’ territory. Therefore, once the initial debt ceiling resolution rally in the USD fades, the correlation suggests that persistent Fed stimulus will be an enormously important factor in driving the risk rally further, especially in light of the factors noted earlier. This persistent negative correlation over time has massively put us in our place on our USD forecasts this year, and we are still reeling from the pain.
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