Always consider hidden risks
Still Expect Volatile Markets: Why So?
March 7 2016  ​( From TradingView, Fred )
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​​The Situation

In these uncertain times, it is interesting to look at the big picture
in terms of financial markets that may explain a lot why we are
under a Volatility macro phase.​​

One of the main factor bringing all that volatility is the strenght
in the US Dollar. As proxy, we will take the US Dollar Index (DXY).

History suggest that based on a 72 weeks rate of change, when
​we have​​​​​ the US Dollar in a positive move like right now, we are
under potential severe spike in terms of financial volatility.

Taking ​​the VIX Index​ (CBOE Volatility Index (VIX) is a key measure
​of market expectations of near-term volatility conveyed
​by S&P 500
​stock index option price) as an example.

As shown by the first chart below, most of the time when we had a stronger US Dollar (a quick increase in terms of positive rate​​ of change - see middle panel), then risk of higher volatility increased also ( VIX Index - Bottom Panel - Ellipses) as history suggest.

But why the US Dollar can have such an impact on Volatility:
1) ​​​A strong dollar is putting pressure on US corporate profits abroad then impacting stock valuations.
2) ​A stronger US Dollar bring lower commodity prices, also bringing huge pressure on producers, especially the peg (or almost peg) country currencies like the Hong Kong Dollar, the Chinese Yuan and the Saudi Arabia Riyal currencies.
3) ​A stronger US Dollar is also painful for emerging markets financial stability. In fact a lot of emerging markets countries and corporation borrows tremendous amount in US Dollar as it is cheaper and easier to get. But when we have a US Dollar getting quickly stronger, then it is increasing in a big way their cost of capital and interest burden as few of them hedge the currency risk.

And adding to the US Dollar strength phase, we have also 3 factors specific to this cycle that is bringing volatility in place:
1) Total decoupling between the US monetary policy (restrictive) with most of the others Major Central Banks.
​2)​ Slowing Chinese economy and the impact on its currency. It is interesting to look the behavior of ​the ​Chinese Yuan
(Second chart below - Yuan Renminbi - candles) ​in relation to the ​Mighty SP500 (bar chart). Not surprisingly to me, the US stock market became quite sensitive of all economic situation in China in 2015 including the exchange rates shifts​.

We can see clearly a regime change since 2014 on the Yuan (USDCNY exchange rate) as it broke the weekly channel that started back in August 2010. Since February 2014, we are trading within an uptrend channel (weaker Yuan against the US Dollar). Both the devaluation process of August 2015 and the Central Bank of China to shift to a basket of currencies bring a spike above the resistance of that uptrend channel.
​​( See second chart below - Top Panel - Uptrend Channel )

3) ​​Global slowdown in monetary aggregates. Must of us follow the shift in rates from Central Banks and try to forecast their impact for the Financials Markets. In fact, Monetary Agregates and Shifts within Central Banks ​Reserves are also a must follow that very few​​​​ of us do.

​​Very few of us realize that at this stage of the economic cycle, already a stealth tightening coming from monetary aggregates started at the beginning of 2014 and to include a global view coming from China:
1) ​St. Louis Adjusted Monetary Base growth
2) ​ China Central Bank Reserves excluding Gold growth
3) US Treasury Bonds Securities held by the Federal Reserve growth

Interesting to note that the SP500 behavior is almost like the major monetary aggregates as shown by the third chart below ( Red Line - SP500 Index )...

​​​​It seems obvious to me that the monetary policy is already restrictive since the beginning of 2014 and the FED is adding to it as it first increase rates in December 2015.

All those factors will keep the risk of spike in volatility and make 2016 as the most volatile year for financial assets since the last financial crisis.


Louis Pasteur
"Chance favors the prepared mind."

Still Expect Volatile Markets: Why So?  $SPY,  $USDCNY #Trading #investing #yuan #SP500

US Dollar Index DXY - Weekly Candles Chart - Top Panel
DXY -  72 weeks Rate of Change - Blue Line -Middle Panel
VIX Index ​​- Green Line - Bottom Panel

​YUAN (USDCNY - Candles - Top Panel )
SP500 Index ( BARS - Bottom Panel )
Year Over Year in %
​St. Louis Adjusted Monetary Base (BASE) Billions$ ( Blue / Left Scale )
Total Reserves excluding Gold for China ​ ( Green / Left Scale )
​US Treasury Bonds Securities held by the Federal Reserve ( Purple / Right Scale )
SP500 Index ( Red / Left Scale )​