Equity markets open 2017 in a sea of complacency. The VIX is bobbing near its 52-week lows and stock investors are convinced that it’s the 1980s all over again.
It may very well be Ronald Reagan redux, as deregulation and a strong dollar create fresh investment flows into the U.S. and as both the Dow and the S&P hit fresh record highs. But history rarely repeats itself that neatly. And as the great Wall Street sage Robert Farrell once said: “When all the experts and forecasts agree — something else is going to happen.”
That’s why I enter 2017 far warier than most of the Wall Street pros, because the bullish scenario just seems too pat. Say what you want about Donald Trump but the man is never boring — which is to say that if you are going to bet on the Trump Administration, you should probably bet on volatility. After all, we are now at a time in history when we are just one tweet away from a crisis.
|Complacent stock traders may get caught off guard as volatility spreads from the bond and forex markets.|
While equity investors have been partying like it’s 1999, fixed-income and currency markets have been far less sanguine as we step into the New Year. In forex and in bonds, volatility is nearly three-times the VIX levels, which should be a note of caution for anyone who thinks stocks will just rise in a nice, neat linear fashion.
Volatility of course is manna from heaven for currency traders who love nothing more than up-and-down price action as they profit from both going long and short. This week, the forex market is chock-full of data with the U.S. ISM and NFP reports taking center stage, but also important releases out of the U.K. will provide some color on the economy there.
In the U.K., the near 20% drop in the pound has suddenly made U.K. Manufacturing highly competitive and the latest PMI reading was the highest value in 30 months. However, U.K. Manufacturing is a minor part of Britain’s economy and traders are far more concerned with the U.K. consumer.
The very same depreciation in the currency that has helped manufacturers since the Brexit vote could spike prices for most U.K. consumers, who import many key goods. On Thursday, the market will be focused on the U.K. PMI Services report, which comprises more than 70% of the economy, with the market looking for a slight pullback. But if the data misses badly, cable could be headed for 1.2000 flash-crash lows as traders continue to worry about the viability of the U.K. economy.
Meanwhile in the U.S., the dollar rally will now have to be backed up by U.S. data. With markets now pricing in three Fed rate hikes in 2017 and a growth of 3%, even the slightest wobble in the U.S. data could send the buck tumbling in a bout of profit-taking. If, however, U.S. news continues to show steady and improving growth, the dollar juggernaut has nothing to stop it. So we could see 1.0300 EUR/USD and 120.00 USD/JPY before the week’s end.