Talking Points:
- Volatility in price action is starting to show for markets like FX, but these are glimmers of activity are still the exception
- For speculative opportunity, obsession over the Dow at 20,000 contrasts to VIX hovering at its natural low
- An extreme in exposure is foreboding with Russell 2000 net spec futures just off a record high and VIX nearing a record short
See the DailyFX Analysts' 1Q forecasts for the Dollar, Euro, Pound, Equities and Gold in the DailyFX Trading Guides page.
Most measures of volatility remain exceptionally low. However, there complacency is starting to thaw around the edges of the financial system. And, given the exposure taking during the months of inactivity, traders should take not of their bearings and the event risk that can start leveraging the amplitude. First the measures are important to distinguish. Basic price action on favorite benchmarks is still shaking off the hangover from the year-end holiday conditions. The S&P 500's and Dow's tight range at record highs shouldn't be evaluated as opportunity as much as it should for risk. Meanwhile, in the implied volatility measures, the disparity in asset classes continues to build. For the equity-based VIX, we are skimming a historical range low.
Not only is VIX hovering just above 10, but we find short-term measures of expected activity are even more deflated. While it is possible to squeeze a little more blood from the stone, it will be very little. Risk is almost fully flushed from the system. As we frequently discuss, that has profound implications for potential versus probability in speculative interest. While sentiment may nudge higher, it will not likely come on the wings of exuberance - a big picture turn in growth or financial activity is certainly not at hand. In contrast, a perhaps slightly lower probability for risk aversion can lead to far more destruction to the system.
We can see the stakes when we consider not just record highs for the likes of the US equity indexes, but also when we look to the exposure in a wide range of assets. For the Russell 2000, the market has surged to a record high that far outstripped former peaks over the past months. Perhaps far more troubling, the already drained potential in VIX hasn't curbed the thirst that speculators have had in short futures exposure for the instrument nearing a record low. With the tally clear, we need to watch for threats to this glassy and ominous stability. In FX volatility, we see a more ready response to the themes that are starting to pick up steam in the background. And, in the coming week we have key event risk - a Brexit update from the UK PM, US CPI, ECB decision, Chinese GDP update - that can shatter the quiet. We discuss the risks in this weekend Strategy Video.
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