Forex Forecasts Signal Possible Onset Of Renewed Low Volatility

The changes in Europe are very nearly equivalent to the degree of error in any forex forecast for this time period. In other words, the analysts are betting that favorable economic data will offset the Fed’s actual raising of rates and the downward pull of bad tidings in Greece. As for Asia, the BoJ will most likely have to become more accommodating to get the desired results, as will banking officials in Australia. A rate cut in Aussieland is already being discussed in the press.

The fundamental outlook has not dramatically changed. Divergence of monetary policy still rules the day, but the vast majority of analysts foresee a slight pullback and consolidation of the greenback, with a resumption of upward appreciation in the fall of the year. The pace of change will be subdued, as investors learn to look more long term, rather than overreact to the monthly release of contrary economic data. Oil prices and related inventories will continue to stagnate, as the closure of rigs and over supply dynamics take a year to work their way out of the market.

Will political tensions heat up again in the Ukraine and the Middle East? Falling oil prices have subdued much of the vocal rhetoric, while sanctions in Iraq and Russia may produce more diplomatic solutions in the long run. In any event, pundits are not seeing the level of saber rattling that plagued 2014. Maybe cooler heads will prevail, but the focus will still be on Greece and its new ruling party. News articles are reviving old thoughts regarding a “Grexit” and whether Germany will tolerate lower productivity gains in the rest of Europe for much longer. Mario Draghi will be tested, but what else is new? As for the UK, they are battling near-zero inflation. Rate increases will occur in 2016, but the timing is in doubt as to which quarter. May elections may also cause reversals.

The U.S. economy will continue to lead, picking up steam in the latter half of 2015 and supporting a rate hike by the Fed in September. The big question mark, however, is China and its impact on the whole of Asia. GDP growth forecasts have continually been ratcheted downwards, now hitting 7%, but is this figure to be believed? Real estate unit inventories are growing well past domestic demand, without any end in sight. The Chinese central bank has eased up on reserve requirements and interest rates to improve liquidity, but it appears that billions in new liquidity have only served to raise stock prices on the Shanghai Exchange, not help small and medium sized enterprises to prosper. Our guess is that Chinese officials learned nothing from similar attempts in the U.S. and Europe. Australia and New Zealand must wait in limbo for growth to accelerate.

Financial markets of late have taken on a more gradual tone, resisting the sudden knee-jerk reactions that have characterized the last seven years. Are markets now emulating the demeanor of central bankers that have created the belief that gradual is always better? Central bankers have already been warning of a massive liquidity crunch, if an event were severe enough to warrant a tidal wave of carry-trade reversals. Capital outflows from emerging market countries have already had an impact, but there is another estimated $11 trillion overhang to deal with. What might the “trigger” be?

1) S&P 500 Earnings Recession: The current bull market is in its sixth year and setting records. Analysts have been forecasting its end for over 18 months, but to no avail. Sooner or later, however, the impact of an appreciating U.S. dollar must be felt on the bottom line of companies that devote more than half of their efforts in overseas operations. The doomsayers are out in force, but opposing opinions have counter arguments, as well. Earnings declined for the December quarter. If they decline again for the first quarter, will the bears get their way? Will stocks plummet, sending investors to the exits?

2) European Politics: Europe and Politics are often synonymous, and 2015 will be no exception. The UK government may soon be tested, but the major focus will be on Greece and its new team of neophytes at the helm. Debt payments are due, and requests for bail out funds may not be honored. Capital flows out of Europe have already begun, but could accelerate in earnest if the threat of another default materializes. The region will also watch Russia, Iran, Syria, and ISIS factions closely, as well, but this is not new.

3) Asian/Pacific Crisis: Asia/Pacific countries sidestepped the Great Recession, primarily due to the prevailing growth dynamics present in China. Global economies, however, are more interconnected than ever before, and what goes around must eventually come around to all participants. China and other tiger economies have benefited greatly from off-shoring activities from the West, but, at the end of the day, the ultimate consumers of manufactured goods have predominantly been Western countries. Eventually, the drop in Western demand has to be felt in more ways than dropping GDP growth from 7.5% to 7%. The Chinese Machine is without an historical predecessor. The downward trend of Chinese economic data is decades long. One would think that something has to give and in a big way. Time will tell.

The current wave of forex forecasts could easily be labeled as flat or steady as she goes. The metaphor that comes to mind is a pot of water, heated to just below the boiling point. A few bubbles can be seen just beneath the periphery, an indication that a larger reaction might be imminent. Central bankers have twisted the international economic infrastructure into a highly coiled spring, but will it unleash its fury all at once or be slowly and gradually unwound? Will the pot erupt into a boiling chaotic system?

There is uncertainty in the market that justifies current daily forex ranges, but we are in a holding pattern, much as with last year at this time. The Average True Range (ATR) for the euro did top up recently, but that was perhaps due to a short squeeze. The Short-euro trade has been heavily populated at record levels on CFTC Commitment of Traders Reports, but the jury is still out on this trade.

Are these forex forecasts to be taken at face value? Forex analysts try to make their best estimates, but they rarely hit the mark. There are just too many variables, especially the ones that are surprises. But in the world of forex, change does spring eternal. Ranging behavior will not last forever. A trend shift will come about, and the best advice is to be prepared for it before it comes.

Risk Statement: Trading Foreign Exchange on margin carries a high level of risk and may not be suitable for all investors. The possibility exists that you could lose more than your initial deposit. The high degree of leverage can work against you as well as for you.

by Tom Cleveland

Written By: Jay Hawk