US Dollar Ranges; Are Markets Complacent Ahead of the Fed Meeting? - Market Minutes
Market Minutes Overview:
- A lack of volatility in the wake of several significant market events – the May US nonfarm payrolls report, the May US inflation report, and the June European Central Bank meeting – has traders focused on the next major event, the June Federal Reserve policy meeting.
- The reality of the situation is that with the UEFA European Football Championship now under way, traders have one less reason to pay attention to markets ahead of the Wednesday fireworks.
- Complacency is indeed the name of the game this week as the Federal Reserve meets. Could stocks still rally? Of course. But if they don’t, the ‘long stocks’ trade is already extremely crowded, and an unwind could be acute.
It’s Still Quiet; Pre-FOMC Drift
Summer trading conditions have arrived, even if the calendar has not yet turned. A lack of volatility in the wake of several significant market events – the May US nonfarm payrolls report, the May US inflation report, and the June European Central Bank meeting – has traders focused on the next major event, the June Federal Reserve policy meeting.
As is somewhat typical ahead of the FOMC, market participants stop placing new trades but rather take some profit and stockpile ammunition to execute on opportunities on the other side of the policy meeting. In general, this leads to quieter conditions and a slow but steady float higher in risk assets. The New York Fed’s Liberty Street Economics blog illustrates this happenstance with this useful chart:
Pre-FOMC Drift: Cumulative Returns for the US S&P 500 (March 2011 to November 2018) (Chart 1)
The point being made here is that if measures of volatility remain depressed (see chart 2 below), we’re now entering the pre-FOMC drift that typically produces quieter trading conditions anyway. And the reality of the situation is that with the UEFA European Football Championship now under way, traders have one less reason to pay attention to markets ahead of the Wednesday fireworks.
GVZ, MOVE, OVX, & VIX Technical Analysis: Daily Price Chart (March 8 to June 14, 2021) (Chart 2)
Independent from the pre-FOMC drift, measures of volatility across asset classes remain depressed.Measured to a base on March 12, three months ago,MOVE (Treasuries volatility) is off by over -28%, the VIX (stock volatility) is down by nearly -19%, GVZ (gold volatility) is down by -13%, and OVX (oil volatility) has come down by nearly -11.5%.
However, a three-month look back on Thursday, June 10, showed that the VIX was down by more than -27%, OVX was off by nearly -15%, MOVE was down over -16%, and GVZ had contracted by nearly -19%. Volatility remains low but with the pace of negative change abating, may be reaching a new equilibrium.
Nevertheless, persistent lower volatility environments typically cater to few breakouts and more rangebound trading conditions; pairs in consolidation will need catalysts to leave their ranges.
Video Technical Notes: DXY Index
- The DXY Index continues to hold below former multi-month bear flag support that defined price action beginning in late-November 2020. In recent weeks, below this multi-month flag support, a shorter-term bear flag has been carved out. But there has been no significant follow through, leaving open the potential for a bullish reversal within the range. Clearly defined ranges offer an opportunity for range trading, although with the Fed meeting this Wednesday, it may be the case that breakout conditions may be hiding around the corner.
Risk Assets at Risk?
The slow death of volatility has been met by a steady march higher in risk assets, in particular US stocks. But it appears that investors may have a bit too much faith in the Fed’s ability to keep the party going when it meets this coming Wednesday.
US S&P 500 & Put/Call Ratio 21-EMA (February 2020 to June 2021) (Chart 3)
The put/call ratio – the relative volume of calls and puts purchased – has been moving towards levels that have been previously consistent with short-term tops in the US S&P 500 since coronavirus pandemic started.
In fact, a one-month moving average of the put/call ratio (using the 21-EMA) shows the ratio moving towards its pandemic lows, suggesting an extremely, if not exhausted, bullish disposition.Complacency is indeed the name of the game this week as the Federal Reserve meets. Could stocks still rally? Of course. But if they don’t, the ‘long stocks’ trade is already extremely crowded, and an unwind could be acute.
Heavy Macro Calendar
The economic calendar is saturated with ‘high’ rated event risk over the coming days, with several data releases due out from around the globe ahead of the Fed’s meeting on Wednesday. Of note: the dual inflation reports due from Canada and the UK on Wednesday morning.
Financial markets have been steadfast in their belief that inflation pressures are “largely transitory” (using the Fed’s language), but a persistent onslaught of above expectation inflation readings could introduce much-needed volatility into sovereign bond markets – and thus FX – ahead of Wednesday’s FOMC fireworks.
DailyFX Economic Calendar, ‘High’ Rate Events, Next 48-hours (Table 1)
--- Written by Christopher Vecchio, CFA, Senior Currency Strategist
DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.