Single-day paroxysms brought about by geopolitical unrest and local black swan events aside, stocks continue to calmly shuffle through a dream-like state of imploded volatility as the “bubble in certainty” persists. While many active investors are focused primary on equities, however, it’s important to recall this condition of zombie volatility is global in scope, sweeping in nearly every asset class across most developed and emerging markets.
One of the most prominent examples of this all-encompassing malaise is the benchmark Euro/US Dollar (EUR/USD) Forex pair. Considering EUR/USD’s position as the single most traded pair in a market with $5-6 Trillion nominal daily turnover, the historically tight volatility stranglehold imposed on it through the Fed and ECB’s shared platform of ZIRP policy activism is almost startling.
Similarly to High Yield Corporate Debt in both the US and Europe, however, amidst it’s subdued behavior EUR/USD is beginning to show signs of the reinvigorated (and healthy) erraticism that is a hallmark of free and liquid markets.
Since Mid-2012 EUR/USD as wound it’s way through a rising wedge that tagged and soundly tested the 61.8% fibonacci retracement of 2011’s high near 1.50 before selling off from 1.40 following ECB President Mario Draghi recent allusions to implementation of additional accommodative measures to stimulate the still-fragile Euroarea recovery.
The increasingly dovish tone out of the ECB came just as EUR/USD pressed into a massive confluence of resistance featuring this 2-year rising wedge, 6-year descending trend line and structured fibonacci cluster resistance at 1.3850-1.40:
EUR/USD has continued to drift lower as Draghi’s references to stimulative measures became concrete policy at the ECB’s June meeting, with the ECB’s overnight borrowing rate going negative for the first time ever as of June 11; along with the introduction of TLTROs.
Then earlier today, the Bank of Italy dampened hopes of the EZ periphery (and 3rd largest sovereign bond market in the world, after the US and Japan) finding a sound footing as it slashed it’s 2014 economic forecast. As the WSJ reports:
The central bank slashed its projection of Italy’s gross domestic product growth rate for 2014 to 0.2% from its January forecast of a 0.7% rise, while it raised its 2015 forecast to an increase of 1.3% versus an earlier estimate of 1.0% growth.
The cut in the Bank of Italy’s forecast for this year comes after ISTAT, the country’s statistical agency, last month lowered its 2014 GDP forecast to a range of between a drop of 0.1% and a gain of 0.3%.
As an apparent result of the BoI’s pessimistic outlook, EUR/USD has (finally?) broken 2-year rising wedge support.
For what it’s worth, with the Fed poised to end it’s asset purchases following it’s October meeting and the ECB locked into a comparatively dovish path as it works to break a persistent threat of deflation (or at least disinflation), the grow policy disparity tilts in favor of a breakdown into the low 1.30s.
But as any trader will tell you, making bets on vague presentiments about price direction inferred from monetary policy is a great recipe for disaster. Whether this break will resolve into a continuation lower is unclear: despite the much-clearer policy backdrop, EUR/USD has developed a well-earned reputation in recent months of being absurdly choppy.
This low volatility era is poised to come to an end, however. The pair’s Bollinger Bandwidth (weekly or monthly) matches all-time lows, indicating that volatility is as compressed over a long timeframe as it has ever been. Similar occurrences in the past are very few: only 4 comparable readings have printed since the inception of the Euro in the late 1990s.
As you’ll note below, when these conditions prevail, EUR/USD volatility soon resumes in a big way; and major range expansions result. Expect more of the same in the coming weeks.
Twitter: @andrewunknown and @seeitmarket
Author holds no exposure to instruments mentioned at the time of publication. Commentary provided is for educational purposes only and in no way constitutes trading or investment advice.
