EUR/USD, USD/JPY, GBP/USD Volatility Extreme Even for Holidays
- Volatility naturally deflates through year's end as holiday conditions curb market participation
- The sudden slump in volatility in the past week relative to the past month has been particularly extreme for the Dollar
- We use a 5-day to 20-day ratio to assess the change in activity levels from a historical perspective
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It comes as no surprise that volatility has collapsed into this final week of the year. The plunge in activity during this period is a reliable seasonal effect that can be shown on a statistical basis through metrics like the VIX and S&P 500 performance but is more often simply referred to through colloquialisms like the 'Santa Claus' rally. However, what is to say that the current deflation is justified rather than plunging levels of inactivity that are extreme even for holiday trade? Historical volatility measures are one means to assess current conditions, but we look at an easily accessible activity with an adjustment.
When looking at the relative volatility conditions, we have to take into consideration the 'holiday' conditions versus more 'normal' liquidity. Further, it is important to assess the general level of volatility through this year-end period compared to previous holiday conditions. To do this, I use a short-term average true range (ATR) and compare it to a medium-term duration. A five and twenty day period for those respective time frames approximate a trading week and trading month, which are appropriate comparisons. Not only does this show us extreme general levels of activity, it further reflects the degree of change which is a measure of intensity all its own.
Using this adapted measure, we can see that many markets are quiet; but the Dollar and its pairings are particularly extreme. The last five-days of trading activity has tumbled relative to the entire month of December to a degree that we haven't seen in years. For EUR/USD, that translates to the sharpest slide in volatility in five years. For GBP/USD, the slump has no equivalent until we go all the way back to 1994. For USD/JPY, the historical quiet and slide in activity matches tense technical pattern - a narrow wedge at the extreme end of a bull trend. While this coiled spring is unlikely to translate into major moves this week, it stages extremes that will rebalance when liquidity returns. How remarkable is the quiet in markets and what does it mean when depth fills back out in the New Year? We discuss that in today's Strategy Video.
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