Vol Stimulants Around The Corner Via FOMC & China-US Trade Talks

Now, I want to go back to the influence that China has been playing over the rest of the world, as no country has been able to ripe the benefits as much as Australia did. If you think about it, the unequivocal underlying reason that the economy in Australia has thrived the way it has since the GFC, even without resorting to any type of QE experiment, is the proximity to China.

But as China started to shift its focus from an industrial-heavy nation into a consumer-driven, which has eventually led to a major slowdown (car sales on a slump, consumption falling off a cliff, etc.), no country is going to feel the effects as much as Australia. With large shares of the country’s wealth tied up to a falling property market, the question was always going to be. Will the domino effect keeps its course from a slower China -> lower house prices -> feedback into the real economy.

After Tuesday’s dreadful NAB’s Australian business conditions, to me, there is no doubt that the economy is teetering on the brink of a major awakening, one in which the first to blink and possibly act is the RBA by cutting interest rates. That’s what bond traders have been telegraphing anyway. Be therefore prepared for the Central Bank to acknowledge the falls seen in auto sales, credit growth, house prices as soon as next week, when policymakers return from its summer mini-sabbatical.

Source: NAB

Risk Events/ Economic Heatmap

source: Forexfactory

Access our heatmap tables organized by countries in the following link.

Charts Insights: What Charts To Pay Attention To?

USD/JPY — Short Setup Ahead of the FOMC

If there is a market where the risk reward ahead of the FOMC appears to be skewed towards the downside judging by the convergence of correlations, that’s the USD/JPY. After a 1-week long consolidation with 110.00 casting a shadow for buyers just overhead, the rolling over of the US 30-year bond yield alongside the pronounced weakness in the DXY is the perfect receipt to see a sell-side campaign in the pair re-emerging. However, with the FOMC just around the corner, you don’t want to keep your exposure too heavily as the initial withdrawal of liquidity will make prices whipsaw very erratically. Look to get involved once the dust settles and the market, through price action, shows its hand, but be aware that the backdrop is a negative one for the pair heading into FOMC day.

AUD/USD — At A Premium Based On Potential Central Bank Divergence

If it wasn’t for the lingering positive effects that the US-China trade talk negotiations have engineered in the price of beta currencies the likes of the Aussie, which also finds its backing from broad-based USD weakness, one would think the pricing of the pair is at an attractive level to short. Especially if you buy into the idea that the RBA may revise down its outlook for the economy and eventually cut interest rates to lessen the debt burden by household and stimulate consumption. However, the price action and correlated instruments (SP500, Yuan, DXY) all show this is not the time to be a hero by shorting the Aussie. Re-assessing the picture post FOMC will be a positive exercise of patience. Besides, AUD outlook has been clouded by its deteriorating fundamentals, while the USD is one of the weakest currencies in the last week, hence the combination of currencies does not seem to be the best to exploit market movements in the next 24h. Throw into the mix the unpredictability of the US-China trade talks this week, and I’d say this is a high-risk pair to get involved this week.

GOLD — Benefits From USD Weakness Like No Other

If one asset class manifests the recent debilitated state in the US Dollar, look no further, that’s gold. In a world where each and every currency carries to a lesser or greater extent negative fundamentals, there appears to be a consensus among the investing community that the precious metal is the safest house in a troubled world with ever increasing tail risks of either further selling in equities or the reversion back to easing policies by Central Banks down the road. Gold has been performing admirably well in times of risk aversion while the falls in times of USD strength and/or risk appetite have been extremely well contained. That should tell us a lot about demand and supply.

Options — 25 Delta RR & Vols

* The 25-delta risk reversal is the result of calculating the vol of the 25 delta call and discount the vol of the 25 delta put. … A positive risk reversal (calls vol greater than puts) implies a ‘positively’ skewed distribution, in other words, an underperformance of longs via spot. The analysis of the 25-delta risk reversals, when combined with different time measures of implied volatility, allows us to factor in more clues about a potential direction. If the day to day pricing of calls — puts increases while there is an anticipation of greater vol, it tends to be a bullish signal to expect higher spot prices.

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The Daily Edge is authored by Ivan Delgado, Head of Market Research at Global Prime. The purpose of this content is to provide an assessment of the market conditions. The report takes an in-depth ...

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