Feb 9, 2016 - ETF Securities FX Research: Volatility turnaround to drive asset class returns. NOK and GBP to outperform.
Martin Arnold Director –FX & Macro Strategist
[email protected]
9 February 2016
ETF Securities FX Research: Volatility turnaround to drive asset class returns NOK and GBP to outperform Summary
Investor uncertainty remains elevated. However, investors differ with consumers, with consumer sentiment on an uptrend, lifted by jobs and low energy prices.
Currency volatility expected to moderate as investors convinced by underlying strength, helping support a ‘risk –on’ environment.
The British Pound has historically had a strong inverse correlation with volatility.
Currencies battered by volatility to turnaround, with Norwegian Krone and British Pound leading the way higher.
While there has been a divergence in recent months between the leading economic indicators and consumer sentiment, there has been strong direct correlation historically. The improving trend in consumer sentiment (buoyed by rising jobs and wages and falling energy prices) suggests that the slowdown in manufacturing and services from survey evidence has the potential to reverse in coming months. We expect that such a development could be the catalyst for a reduction in market volatility as investors become more confident in the solid underlying economic fundamentals.
Volatility elevated
Sentiment divergence
80
Investor uncertainty, which manifests in greater asset return volatility, has been driven primarily by uncertainty surrounding US central bank policy, the softer growth outlook for China, and plunging oil prices. However, investor sentiment stands in stark contrast to consumer sentiment. As a result, there appears to be a fundamental disconnect between returns for cyclical asset classes and the underlying economic fundamentals, particularly in the US. While market participants appear to be focussing on softening metrics like manufacturing and industrial production, consumer sentiment is breaking higher and likely to underpin activity in both the services and manufacturing sectors.
60
Sentiment divergence 80
100
70
80
60
60
50
40
40
20 Developed economy leading economic indicator(lhs)
30
0
Developed economy consumer sentiment index (rhs) -20
50
OIV (lhs)
16
VIX (lhs)
14
FXVIX (rhs)
12 10
40
8
30
6
20
4
10
2
0 Sep 10
0
Sep 11
Sep 12
Sep 13
Sep 14
Sep 15
Source: Bloomberg, ETF Securities
Nonetheless, asset market volatility has been at multi-year highs for many asset classes in 2016. Although volatility has continued to rise in recent weeks for oil (OIV) and for currencies (FXVIX), it has begun to moderate for equities (VIX). During periods of elevated (or depressed volatility), movements tend to be consistent across asset classes. However, one indicator that could be the herald for more market stability is the volatility of volatility. The volatility of volatility has been moderating for all asset classes, indicating that volatility is lessening. This means that the investor uncertainty might be waning and could lead to a reversal of the ‘risk-off’ trend that has been in vogue in 2016.
Jan 90 Nov 90 Sep 91 Jul 92 May 93 Mar 94 Jan 95 Nov 95 Sep 96 Jul 97 May 98 Mar 99 Jan 00 Nov 00 Sep 01 Jul 02 May 03 Mar 04 Jan 05 Nov 05 Sep 06 Jul 07 May 08 Mar 09 Jan 10 Nov 10 Sep 11 Jul 12 May 13 Mar 14 Jan 15
20
18
70
Source: Bloomberg, ETF Securities
For Investment professional use only, not for public dissemination – Past performance does not guarantee future results.
2
ETF Securities Research 2016
Volatility to moderate 180
25
OIV (lhs)
160
VIX (lhs)
140
20
FXVIX (rhs)
120
15
100 80
10
60 40
Norwegian Krone, following the sharp rebound in oil prices. If oil prices stabilise in line with volatility, this could be the beginning of a sustained rise for NOK (and its oil counterpart CAD, which has lagged the oil bounce thus far). Indeed, while it has outperformed in 2015, it is still well below its levels of a year ago, with plenty of upside potential.
Implications for the US Dollar
5
20
Investor optimism over the strength of the US Dollar is beginning to fade ahead of the key March FOMC meeting.
0
Sep 12
Sep 13
Sep 14
Sep 15
Source: Bloomberg, ETF Securities
Investor positioning
60000
20000
105
0
100
Sep 15
Jan 16
Jan 15
May 15
Sep 14
May 14
Sep 13
Jan 14
Jan 13
May 13
90 Sep 12
-40000 May 12
95 Sep 11
-20000
Source: Bloomberg, ETF Securities
0% -2% -4% -6%
VIX
JP Morgan Global FX Volatility
Long JPY Short EUR
Long USD Short EUR
Long USD Short EUR
Long CHF Short EUR
Long SEK Short EUR
Long GBP Short EUR
Long CAD Short EUR
Long NOK Short EUR
Long Euro Basket
Long AUD Short EUR
Long NZD Short EUR
-8%
Source: Bloomberg, ETF Securities
The British Pound has been the worst performing G10 currency, with the exception of the New Zealand Dollar. The poor performance is not surprising as GBP tends to be inversely related to volatility. However, in coming months we expect this weakness to moderate as market volatility gradually fades. 21
1.35 GBP/USD (RHS)
JP Morgan Global FX Volatility (LHS)
19
1.4
17
1.45
15
1.5
13
1.55
11
1.6
9
1.65
7
1.7 1.75 Feb-10
Feb-11
Feb-12
Feb-13
Feb-14
We continue to believe there is modest upside to the US dollar in coming months as the underlying robust economic fundamentals reappear, but then we see a peak as the improving economic backdrop is fully priced into interest rate expectations for the FOMC in 2016.
G10 (per EUR) (%chg) New Zealand Dollar British Pound Australian Dollar United States Dollar Swedish Krona Swiss Franc Canadian Dollar Japanese Y en Danish Krone Norwegian Krone
NZD GBP AUD USD SEK CHF CAD JPY DKK NOK
Year-to-Date -4.41 -4.14 -4.01 -2.82 -2.23 -2.13 -2.08 -0.13 -0.03 0.99
12 Mth -3.78 -2.21 -3.3 2.83 0.34 -5.53 -6.57 2.61 -0.79 -8.57
Source: Bloomberg, ETF Securities
Volatility weighs on GBP...
5 Feb-09
110
Jan 10
Monthly Data in EUR, From Nov 05 to Jan 16
2%
115
40000
May 10
Falling volatility environment
4%
120
USD Basket Index (rhs)
Jan 11
Certain currencies perform better in high volatility environments while others perform better in low volatility environments. During 2016 thus far, there have been several key currency trends that are worth highlighting as volatility begins to decline to more historical norms. (See relative performance tables below).
125 Net Non-Commerical USD futures positions (lhs)
80000
Sep 10
What does this mean for currencies?
100000
Jan 12
Sep 11
May 11
0 Sep 10
Feb-15
Source: Bloomberg, ETF Securities
G10 (per GBP) (%chg) New Zealand Dollar Australian Dollar United States Dollar Swedish Krona Swiss Franc Canadian Dollar Japanese Y en Danish Krone Euro Norwegian Krone
NZD AUD USD SEK CHF CAD JPY DKK EUR NOK
Year-to-Date -0.22 0.2 1.45 2.06 2.16 2.21 4.26 4.36 4.38 5.43
Source: Bloomberg, ETF Securities
The best performing currency by far in 2016, has been the
Investments may go up or down in value and you may lose some or all of the amount invested. Past performance does not guarantee future results.
12 Mth -1.03 -0.54 5.76 3.21 -2.83 -3.9 5.54 2.04 2.81 -5.96
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ETF Securities Research 2016
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