The Central Bank of England volatility index of since last week is known as the best indicator of fear in the forex markets, dropped to a record low of below 9.
The declines were a result of steady equity markets, low forex trading volumes, and optimism that the markets were heading higher.
This has all changed in the past two weeks- the fear index rallied from a low of 9.52 to 17.28, an 81% spike in 4 days from Aug 8 to Aug 11.
This was precipitated forex markets rising tensions between the U.S. and North Korea markets. These tensions lasted for a couple of days, and then eased after both sides backed down.
However, the calm didn’t last long, as President Donald Trump response to the Charlottesville clash, saw business leaders exiting his advisory councils, and a number of high profile Republicans criticizing and distancing themselves from the President.
The departure of Donald Trump’s Chief Strategist Steve Bannon, mainly seen as pushing protectionist policies, was not unexpected and it was slightly positive for forex markets, causing U.S. stocks to rally on Friday, but the market ended near lows.
Politics have clearly taken the front seat, and another shock will likely lead to a further selloff in equities. Some investors might see the recent fall in prices as an opportunity to buy the dips, but given that valuations are still very high compared to historical averages, many will hold off until seeing meaningful fiscal policy change.
Donald Trump’s administration will be tested as we get closer to hitting the U.S. debt ceiling. According to the Congressional Budget Office, the debt limit should be raised by mid-October, to avoid defaulting on loan payments, but this time it doesn’t seem a done deal.
Given that the economic calendar doesn’t hold tier-one data this week, investors and forex traders will be focusing on the Jackson Hole central bank gathering on 24-26 August.
The two stars of the gathering will undoubtedly be Mario Draghi and Janet Yellen.
The most recent minutes from the Fed and ECB, shows that inflationary pressures remained absent; despite declining unemployment.
When looking at bond yields across the globe, forex markets investors seem to be convinced that inflation isn’t returning anytime soon. However, financial asset prices are worrying central bankers, especially the Fed, which sees valuations as elevated.
With ECB’s meeting scheduled on September 7, Euro traders are waiting for signs from President Draghi as to when the central bank will start trimming QE.
The single currency managed to overlook ECB’s minutes, which revealed that Euro strength is becoming a concern for monetary policy makers. If Draghi does not disclose his plan for tapering QE, the Euro might fall towards 1.16, but I would prefer buying the dips then selling the rallies, as the ECB have no other choice but to tighten policy.