Even Good Data Boost Lift FX Volatility

Volatility in the forex market is at its lowest level in 5 years and according to many analysts, breakouts are right around the corner. The VIX, which measures the volatility in the US equity market is a third of what it was in December. Even today's busy economic calendar failed to trigger any meaningful let alone big moves in currencies. China reported significant improvements in retail sales and industrial production along with an uptick in first quarter GDP that drove AUD/USD to its strongest level in more than a month. Yet by the end of the NY session the rally fizzled and the pair gave up all of its earlier gains. Stronger EZ trade data failed to help the euro and the gains in the Canadian dollar were modest despite higher inflation and a stronger trade balance. It would be easy to attribute the lack of movement to the upcoming Easter holidays but volatility has been subdued for weeks. From a historical perspective, the potential for an explosion in volatility is significant but on a fundamental basis, there isn't a clear catalyst. Brexit won't be a pressing issue for another 4 or 5 months, US-China trade talks are progressing positively and no additional policy changes are expected from major central banks this year. If stocks continue to rise, volatility will remain low.

Volatility will only come back if stocks crash. With stocks hovering near 6-month highs, investors are complacent. A sharp sell-off in stocks would be the tipping point that triggers widespread profit taking and broad based risk aversion - we got a good taste of that in December and January. The only question is what could cause a turn in sentiment. We know that central bankers are worried about global growth and the moves in equities fail to recognize these concerns. Stocks could peak if US-China trade talks turn south or the EU-US trade war heats up. If earnings are weak or data stabilizes enough for central banks to reconsider tightening, rate hike talk could also drive stocks lower. Sometimes stocks correct for no reason at all - they sell-off sharply one day and the fear of further losses drive them even lower.

In the meantime, the latest economic reports suggest that China's massive stimulus package is working. Consumer spending and manufacturing activity rebounded strongly in the month of March. GDP growth eased in Q1 but the year over year slowdown was less than anticipated. These reports drove AUDUSD to a fresh 1 month high and took NZDUSD off its lows but the rallies were unsustainable as it is far too early to declare a bottom in China's economy. The Reserve Banks of Australia and New Zealand have rate cuts on their minds and last night's CPI report from New Zealand hardens the case for easing. The smaller than expected increase in prices caused the year over year CPI rate to fall to 1.5% from 1.9% and NZD/USD to tumble to a fresh 3 month low of .6670. Australia's labor market report is scheduled for release this evening and while stronger job growth is expected, the unemployment rate is also tipped for a rise.

USD/CAD ended the day unchanged despite a stronger than expected trade balance and rise in CPI. Immediately after the data was released, the Canadian dollar soared but like AUD and NZD, gave up all of its gains in the hours that followed. Part of the move was attributed to the turnaround in oil prices but as we mentioned in yesterday's note, the Bank of Canada is dovish and even If these reports are stronger, they will not change the central bank's perspective. Tomorrow's retail sales report on the other hand is very important because spending is expected to turn positive for the first time in four months.

Thanks to a stronger Eurozone trade report, EUR/USD is still hovering around 1.13.The real test for the currency will come in the form of tomorrow's PMI reports. If the data shows that manufacturing and service sector activity grew at a faster pace in April, EUR/USD could squeeze up to 1.1350. However if activity remains subdued, 1.13 would be a confirmed top. US and UK retail sales are also scheduled for release. Consumer spending in the US is expected to rise strongly on the back of higher gas prices, low interest rates and equity market strength. Spending in the UK on the other hand should remain weak. Inflation in the UK remains subdued according to their latest inflation report.