After reaching a 5 year low in volatility, a change may be underway. The return of risk into the broader system and the gradual return of investment capital into the regular investment arena are likely to send volatility upwards in the first 3 to 6 months of 2013, says John Kicklighter of DailyFX.
In the interview below, Kicklighter discusses volatility, the impact of the LDP on the yen, what is priced in for the fiscal cliff and more.
John Kicklighter is a currency strategist for FXCM in New York where he specializes in combining fundamental and technical analysis with money management. John authors a number of regular articles for DailyFX.com, ranging in topics from basic fundamental forecasts for the G10 economies and commodities to more complex subjects like the level of risk sentiment across the financial markets and the carry trade specifically. John has actively traded since he was a teenager. His experience ranges from spot currency, financial futures, commodities, stocks, and options on all of these instruments for his personal accounts. John graduated from the Zicklin School of Business at Baruch College in New York with a Bachelors degree in Finance and Investment.
1. Following the landslide victory of the LDP in Japan, do you think the yen could further weaken before the year ends, or could it take action from the new government to see such a move?
There are two factors that will work against further yen depreciation. First we have the natural inclination for short to medium-term traders to unwind speculative positions (like the long carry that yen crosses represent) into the end of the year. That is a natural pull on the market. The other consideration is the ‘buy the rumor, sell the news’ aspect that we often seen with major event risk like this. However, it seems that income Prime Minister Abe is aware of that factor. This week he has already removed the budget spending cap and has gone to visit the BoJ governor – presumably to push forward his demands for further, aggressive stimulus (this is why we keep hearing about the 2 percent inflation target). If they can keep the stimulus effort continuously building through year-end, we could still advance (see the yen decline). However, all that would be rendered moot if risk aversion kicks in. Policy officials have a non-existent record when it comes to fight sentiment flows that unwind carry and leverages safe havens.
2. There are reports about progress in the “fiscal cliff” negotiations. After QE4 has been announced and Greece received the tranche of aid, could an announcement of a deal before the holidays further push the dollar lower? Or could we get a different response?
While it looks like there is a general consensus within the market that the US will come to a deal to avoid the Fiscal Cliff (otherwise, you wouldn’t have seen markets advance with such tenacity these past four weeks), the impact that the alternative scenario would carry is just so severe that there is ‘insurance’ positioning in the market in case it does happen. That means that if there is a resolution, you are likely to still see some advance from equities and risk (losses for the dollar). However, it will lack for follow through as this is still the illiquid holiday trading period. If we ‘go over the Cliff’, it would have a significant impact on the pumped up premium in capital markets and the dollar would advance. Of course, the pace will be dictated by the market conditions.
3. NZD/USD reached highs last seen in 2011. Could the central bank intervene to lower the currency, or is the bar too high at the moment.
There have been a few efforts to intervene on behalf of the New Zealand dollar over the past few years by the RBNZ. The efforts have been dubious at best. In each of the efforts, the market has bowled through the unusual activities as underlying risk trends have kept a consistent flow of investment capital to offset their otherwise modest influence. The kiwi is considered a major currency because it is treated as an investment destination for global capital. To have the Central Bank deliver a modest decrease in the exchange rate will not permanently curb the inflow of capital seeking high yield returns in the country’s highly rated debt. At this point, many of the conditions laid out for intervention have been met. However, both Finance Minister English and RBNZ Governor Wheeler have voiced their lack of confidence that such a move would have any lasting influence.
4. The SNB has left policy unchanged once again. What would convince them to remove the peg? Is a change in policy still far away?
They wouldn’t move the peg unless they were absolutely forced to. There is little benefit to raise the floor on the EURCHF up from 1.2000 to a higher level as they will simply face the same issues and have a larger initial outlay to drive the exchange rate higher to return there. The issue that faces policy officials in Switzerland is that there is a steady capital outflow from the Eurozone as people look to protect their wealth from financial uncertainty and taxes. Individuals and corporations don’t mind that they won’t see an advantageous exchange rate move (EURCHF drop) if they move their capital into the Swiss banking system. They simply want the peace of mind of security. And, they won’t be lifting the floor altogether unless they were confident in the recovery of the Eurozone financial situation – as that is the source of their problems.
5. Looking forward to 2013, could we see volatility picking up after a few relatively slow months? What could trigger a move?
We will likely see volatility pick up in the first six (if not first three) months of the year. We are currently scraping along at the lowest levels of activity in 5 years and that is largely predicated on the lowest level of participation in 15 years. There are two ways that volatility and trend pick up going forward. First, we see the return of a serious risk to the broader system – or at least a large portion of it. That fear could send capital racing away from risky assets and into safe havens, thereby supplying the fear that sets off the insurance premium readings that indicators like the VIX represent. The other option is to see investment capital slowly return to the regular investment arena (carry trades, equities, etc). If that occurs, we will see volatility measures slowly pick up as participation fills out for the normal ebb and flow of risk appetite.
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