The risk-on rally of the past month continues to rage ahead, equities in the US are touching extreme overbought levels, but markets have not crossed levels that signal ‘complacent’ however, they are edging closer. 

One indicator we are watching closely is the relationship between implied and realised volatility. Implied volatility tends to follow realised volatility – therefore in the current market scenario the more markets remain ‘calm’, the lower implied volatility will tick. This will catch markets off guard when a shock is triggered – examples include Brexit, US-China trade issue, Hong Kong unrest.

From a currency perspective, it's around rates and in particular the potential of rising US rates. 

Seeing interest rates and equities rising simultaneously historically is an indicator of global reflation, however, historically corporate didn’t have the level corporate indebtedness US firm, in particular, have currently and this is coupled with a worsening corporate profit outlook. 

Thus, if rates are to rise in 2020 debt consolidation would be expected having come off peaks. These consolidation periods tend to be associated with slow growth and currency weakness – which argues poorly for USD. Certainly, something that is forming a basis for currency trading over the coming months. 

Now, the Fed at the October meeting did set the bar rather high for it to move rates in either direction. Now clearly the absence of rate hike risk should keep USD rates contained, helping to reduce the USD's rate variance. 

But, we also argue that the Fed's nonchalant position to cutting further is USD bearish as the backstop that has been monetary policy may need a ‘bigger nudge’ to prop up the market. 

Meanwhile, the absence of rising political risk from the US-China trade war and to some extent Brexit should support USD selling with particular risk currencies such as GBP, AUD and EMFX. Therefore, a break below the mid-October low of 97.14 in DXY would be a confirmation of our expected USD bearish signal.

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