October is a scary month and not just because of Halloween. Equity markets have a history of melting down and so far, this October hasn’t disappointed. Since June, FX traders (and equity traders as well) have enjoyed a trending market. The dollar was going higher, everyone knew it and judging by the recent price action, everyone was in it. This week’s action just re-introduced an element of two-way risk.
Market movers can be misleading
There are a lot of reasons that have been bandied about to explain this volatility and some of them are as aromatic as freshly spread manure.
1) US retail sales were down 0.3% in September which was 0.2% worse than what was forecast
2) Global economic growth is faltering. Chinese and German economic growth is slowing. The Eurozone faces ongoing deflationary pressures.
3) The Federal Open Market Committee is likely to delay hiking US interest rates until 2016
4) The Ebola virus is spreading in the US. Oh, my god, Stephen King got it right when he wrote “The Stand”
5) Collapsing oil prices will fuel deflationary pressures, further undermining the global economy.
The declining price of oil is the only real threat to the global economy. Photo: Thinkstock
The devil is in the detailsSometimes it is extremely hard to see the forest through the trees and the last couple of sessions have been like that.
Retail sales: Was a US retail sales miss of a mere 0.2% really worth a 0.0200 point spike in EURUSD? How does this tiny one month deviation translate into a virtual confirmation of a global economic slowdown? It is a tad perplexing considering that the US Census Bureau also reported that retail sales gained 4.3 % year over year. The following graph doesn’t show much evidence that consumers are keeping their wallets closed.
Chart: US retail sales change year over year
Global economic growth: There is a difference between a global economic slowdown and a global economic collapse. The recent and current volatility in worldwide equity indices and FX markets would seem to indicate that the economic world as we know it, is coming to an end.
The global economy didn’t just start to slow in the past week - it has been occurring for several months. In fact, global growth forecasts have been steadily reduced to about 3% now, from 3.7% at the start of the year. That is a long way from a collapse but you wouldn’t know it based on the recent FX and equity market price action.
Chart: GDP world growth (Australian perspective)
US rate hike delay: The prevailing wisdom is that the slowing global economy will force the FOMC to push back the first rate hike beyond the middle of 2015. This sentiment got traction because vice chair Stanley Fisher opined last Saturday at the IMF meetings that “if foreign growth is weaker than anticipated, the consequences for the US economy could lead the Fed to remove accommodation more slowly than otherwise”.
For some reason, FX traders ignored the part where, according to Bloomberg, he said that the betting in the financial markets on the timing of a US rate hike appeared “roughly” on the market given the Fed’s current expectations on how the economy’s recovery would unfold. In addition, Fed chair Janet Yellen is rumoured to have told a private meeting around the same time as the IMF meeting that the US economy looked to be on track to achieve growth of 3%. She may use Friday’s speech to reiterate these same views
The Ebola virus is spreading in the US: It is a heck of a stretch to equate one or two Ebola virus cases in Texas to a pandemic that would seriously degrade the US economy. The disease has killed over 4,300 people in West Africa but it is an area without the quality of healthcare available in America. Ebola is a human tragedy and nothing to sneeze at but at this point it is merely a distraction for FX traders.
Falling oil price: WTI oil prices have dropped from $107.40/bbl in June to $80.75/bbl today on a combination of a slowing global economic outlook, increased oil production from the US, slowing demand from China and Saudi Arabia reportedly seeking market share rather than price support.
This is probably the most valid of the reasons to help explain the recent FX volatility but then only for a few of the major currencies. Bloomberg reported that a Bank of America economist claimed that a 20% drop in the oil price would shave off 0.5% from global inflation. In an environment like the Eurozone - and Canada to a lesser degree - where the central bankers have been vocal about deflation, this would put downward pressure on the currencies.
Lower prices will have a serious impact on the economies of the oil producing nations due to diminishing economics. Russia, already suffering from G-7 led sanctions, would be hurt even further and it is not wise to poke an angry bear.
The trend is your friend
The volatile price swings in FX markets over the past few days are evidence of markets that may have been caught bobbing when they should have been weaving. The lack of a clear catalyst validated dubious data releases and the moves were exacerbated by numerous headlines proclaiming “collapse" and "pandemic". As the dust settles, in the case of EURUSD, GBPUSD, USDCAD and AUDUSD, the following charts show that despite the erratic price moves the dominant US dollar downtrend remains intact.
Six month EURUSD, GBPUSD, USDCAD AUDUSD
Enjoy the ride
It is not the end of the world and that means there are plenty of trading excuses. The volatility should be embraced as it provides the active FX trader many opportunities to profit from sharp price swings. Many, many years ago, when the first Gulf war was about to begin, the chief trader at a global bank said to the FX traders “The war is about to start and markets will be volatile. Use your limits, that’s what they are there for.” It may sound reckless but in the context of spot trading, you have to be “in it to win it” especially when rare bouts of extreme volatility strike. Good luck and enjoy the ride.