A Few Brief Comments On The Technical Condition Of The Dollar

 

Driven by the real and anticipated divergence in economic performance and trajectory of monetary policy, the long anticipated US dollar recovery has begun.  As is evident in the positioning of the futures market, and confirmed by anecdotal evidence, speculative participants have amassed a significant large US dollar position. Broader measures of portfolio flows are less timely, but those that track mutual fund and ETF flows also report foreign demand for US assets.  

The two knocks against the currency market have been the lack of follow through and the low volatility.   The former has been exaggerated, and the latter may be changing.  Perhaps what many say was the lack of follow through was really about being on the wrong side of the trade.  Rather than continue to rally, the dollar’s advance against the yen stopped dead in its tracked at the start of the year.  Sterling trended higher from around $1.65 in mid-March to $1.72 in mid-July and that back to $1.65 in late-August.    Sterling’s recent decline including a 7-week losing streak that ended last week (just barely).  And with last week’s losses, the euro itself has declined for seven consecutive weeks.  

Volatility in the euro and yen have been moving higher.  The three-month implied volatility of both the euro-dollar and dollar-yen spent last week above their 100-day moving averages after bottoming in mid-July.   For the euro, it is the first time since the start of the year, and this is the longest the implied dollar-yen vol has stayed above its 100-day average since the middle of last year.  

Sterling is an exception to the general pattern of a stronger dollar, higher volatility.  Sterling peaking against the dollar in mid-July, but the implied volatility peaked a few weeks later in early August. Perhaps at when sterling fell through a technical retracement objective near $1.68, the option players only then recognized that a top of some import was in place and were no longer looking to buy upside protection.  As the sterling has moved back into more familiar levels, volatility has continued to ease and is back to within striking distance of the multi-year low set in June near 5%.  That said, we can see how an out-of-the-money options could offer attractive returned if the Scottish referendum in the middle of September surprises or, if once passed this key event, sterling rallies.