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Forex Strategy: Volatility Increases Just as NFPs Approach, A EURUSD Break?

Forex Strategy: Volatility Increases Just as NFPs Approach, A EURUSD Break?

2012-11-01 21:45:00
John Kicklighter, Chief Currency Strategist
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Trading conditions are very different for the Forex and capital markets now than they were at the beginning of the week. With US traders returning to the market having been knocked offline over the opening 48 hours due to Hurricane Sandy, there is a sense of ‘catch up’ to trading conditions. However, the pickup in activity does not have the influence alone to generate meaningful breakouts and trend generation. We need a fundamental drive to accomplish this.

It just so happens that this Friday brings the media-favorite US NPFs for October. Though this data series has not carried the sway it had five years ago (often proving the impetus for lasting trends), conditions are aligning such that this particular release can leverage far more activity from the markets than usual. Critical is the level of ‘surprise’ in the release as well as the event’s ability to tap into ‘risk appetite’ trends.

Market Conditions

Forex_Strategy_Volatility_Increases_Just_as_NFPs_Approach_A_EURUSD_Break_body_Picture_5.png, Forex Strategy: Volatility Increases Just as NFPs Approach, A EURUSD Break?

One of the primary reasons we can expect significant activity following this wave of event risk is the situation with risk trends. Sentiment is split into ‘risk’ and ‘reward’, and when we look at the balance (above), it is evident that there is considerable room for an explosive reaction to a surprise from an indicator that often captures the full attention of the markets. In this chart we can see that yields are very low (just off historical lows), but it is Forex market volatility (FX VIX Index) that is the most sensitive at five year lows. That puts a greater influence to a negative outcome that stirs ‘fear’ to play to the sensitivity of the volatility levels.

Below, we can see the imbalance of market against risk trends. The Dow Jones Industrial Average is not far off four-year highs, but for the time being it is capped by well worn resistance at 13,300. An upside surprise can certainly deliver a boost; but at these highs, a modest improvement to a weaker series like employment will struggle for trend. Alternatively, the weight of markets at such heights exposes a market highly skeptical and sensitive to a downside move.

Forex_Strategy_Volatility_Increases_Just_as_NFPs_Approach_A_EURUSD_Break_body_Picture_6.png, Forex Strategy: Volatility Increases Just as NFPs Approach, A EURUSD Break?

The Setups

The potential for volatility alone plays to attractive technical setups in the FX market. There are plenty of ‘risk aversion’ outcomes that would find the market primed for response. Below we have the EURUSD which would align to a technical break below 1.2900 and then 1.2825 for a deeper retracement. That said, the dollar and yen would generally benefit roundly from major ‘risk off’ outcomes.

Forex_Strategy_Volatility_Increases_Just_as_NFPs_Approach_A_EURUSD_Break_body_Picture_7.png, Forex Strategy: Volatility Increases Just as NFPs Approach, A EURUSD Break?

On the other hand, if we do have a positive surprise which can actually lift speculative appetite and confidence (just seeing a bigger number than expected may not do it), there are a few setups like the Dow’s 13,300 resistance that can provide a short-term break to the upside. A good example is AUDUSD which is currently holding just below 1.0400.

Forex_Strategy_Volatility_Increases_Just_as_NFPs_Approach_A_EURUSD_Break_body_Picture_8.png, Forex Strategy: Volatility Increases Just as NFPs Approach, A EURUSD Break?

Past NFP Reaction

To give a sense of how market-moving the NFPs have been in the past, the below graph shows how the EURUSD traded in the hours following the employment report’s release. We can see that there is a cluster that trends towards moderate reaction. General trading conditions tempered the market’s response in most of these cases, which sets a contrast to the markets we see today.

Forex_Strategy_Volatility_Increases_Just_as_NFPs_Approach_A_EURUSD_Break_body_Picture_9.png, Forex Strategy: Volatility Increases Just as NFPs Approach, A EURUSD Break?

The Big Picture of US Employment

Forex_Strategy_Volatility_Increases_Just_as_NFPs_Approach_A_EURUSD_Break_body_Picture_10.png, Forex Strategy: Volatility Increases Just as NFPs Approach, A EURUSD Break?

This is the benchmark with which most investors will judge the data. The change in NFPs is the benchmark and first read by which traders will gauge ‘better’ or ‘worse’ than expected.

Forex_Strategy_Volatility_Increases_Just_as_NFPs_Approach_A_EURUSD_Break_body_Picture_11.png, Forex Strategy: Volatility Increases Just as NFPs Approach, A EURUSD Break?

Bigger picture, however, we can see in the larger health of US labor that there is still serious slack – enough to keep the economy trending towards a global slowdown and the Fed on its stimulus track.

Forex_Strategy_Volatility_Increases_Just_as_NFPs_Approach_A_EURUSD_Break_body_Picture_12.png, Forex Strategy: Volatility Increases Just as NFPs Approach, A EURUSD Break?

Sector Employment Readings

Forex_Strategy_Volatility_Increases_Just_as_NFPs_Approach_A_EURUSD_Break_body_Picture_13.png, Forex Strategy: Volatility Increases Just as NFPs Approach, A EURUSD Break?

What the Fed Sees

And, to give a general sense of what this data means to the economy and policy (rather than speculative reaction), we can see below what the Federal Reserve usually looks at as its mandates for monetary policy. We can also see how effective the response from the central bank has been towards its primary objective: full employment.

Forex_Strategy_Volatility_Increases_Just_as_NFPs_Approach_A_EURUSD_Break_body_Picture_14.png, Forex Strategy: Volatility Increases Just as NFPs Approach, A EURUSD Break?Forex_Strategy_Volatility_Increases_Just_as_NFPs_Approach_A_EURUSD_Break_body_Picture_15.png, Forex Strategy: Volatility Increases Just as NFPs Approach, A EURUSD Break?

--- Written by: John Kicklighter, Chief Strategist for DailyFX.com

To contact John, email jkicklighter@dailyfx.com. Follow me on twitter at http://www.twitter.com/JohnKicklighter

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