Low Volatility

Easing financial conditions and low volatility are an attractive environment for risky assets, as small caps in the US especially continue to outperform.

Questions over how long this “perfect world” can last will of course continue. This “Goldilocks” environment – where the economy is not too hot, or too cold but just about right – is weighing on volatility with markets now in need of a new catalyst. The mega rebound in risky assets has slowed as inflation and Covid variant concerns begin to mount, with last week’s US jobs report not providing as much direction as many would have hoped.

Jobs data inconclusive

While the headline payroll number was mildly disappointing, it was close enough to the consensus number to avoid a major panic about the previous month’s astoundingly weak figure. On the flip side, hourly wage growth came in noticeably higher than expected which adds to the concerns going forward of not-so-transitory pricing pressures, this time in wages.

Perhaps the central issue is that there are still over seven million jobs which have still been lost since the pandemic began and it will take time for this number to come down. Reluctance to go back to work due to Covid concerns, stimulus benefits still being paid out and older people not returning to work all add to the employment puzzle.

Rangebound FX

Falling US bond yields and stable real yields does mean mainly directionless USD trading, with one of the central supports for the greenback potentially ebbing away. Indeed, the FX options markets, which thrive on volatility and sharp directional moves, are trading at or very near to pandemic lows. This tells us that the outlook for broader FX is not going anywhere fast, in the eyes of options traders.

And yet, the more FX markets trade in a range and consolidate sideways, the greater the potential breakout will be which is more often than not, in the direction of the long-term trend. Similarly, risk assets need frequent Fed comfort that the stimulus punchbowl won’t be taken away sooner than expected for the grind higher to continue.

Written on 09/06/2021 12:00 GMT by Lukman Otunuga, Senior Research Analyst at FXTM

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