Wednesday, May 7, 2014

Yen goes sideways due to low Forex volatility | …but here is a pair we like: EURGBP

As already flagged, volatility in the Foreign Exchange markets is at a low ebb at present. Traders do not like wild moves that signal very high volatility, but they need some of it in order for profits to be made on currency exchange rate moves. Right now they would ideally like a little more.

The chart for USDJPY, which is one of the world’s major currency pairs, shown above, illustrates the sideways affect on price of such a low level of trading activity in the market. The fact that price has now coincided with the 200 Day Simple Moving Average might, just might, be enough to trigger some kind of reaction, but it would be foolhardy to bet on it in either direction.

According to the textbook understanding of volatility in Forex, it has three characteristics: It is cyclical, and we are undergoing a low segment in that cycle at present; it is pervasive, in the sense that it tends to be self fulfilling. Traders who see little reason to enter the market today will, most likely, feel the same way tomorrow; and it reverts to the mean. What this last means is that low (or high) volatility does not last. 

However, a change from low to high requires a catalyst. The most obvious candidate for this, based on history, is a resumption of interest rate rises in the developed economies. Apart from some early hints of such as thing happening in the UK, there is very little in prospect in this area anywhere else, apart from relatively tiny New Zealand. Another trigger could be a severe correction in equities. This looks somewhat more likely, for a number of reasons. Or there could be a major escalation in geopolitical crises. Watch out for Ukraine.

Or we could, of course, have a black swan event.

…but here is a pair we like: EURGBP

The Euro against the British pound (EURGBP) has been in a down trending channel since the middle of last year (2013). Fundamentally, as can be seen in its rise against the US dollar, the pound is robust at present. So is the Euro, but its strength is not as compelling, due to the deflation fear and the possibility that the ECB will, at some stage, do something to counter this.

EURGBP is now approaching a level of support. If this were to be breached, and the down channel reinforced, there is no reason why the pair could not continue to the downside for some time to come.

Later today we will have interest rate decisions in both the UK and the Euro zone. We also have monetary policy statements and, in the ECB, a following press conference. Decision in both jurisdictions, and the words of Mario Draghi at the press conference, could have a profound effect on this pair.

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