A rarely known index is sending shockwaves through professional currency trading desks all around the world. The JP Morgan Global FX Volatility Index is now warning of an imminent explosion in the US dollar.
Over the past 25 years, there have only been three troughs in the index and each time the US dollar exploded 10%. The volatility index is now trading at the lowest in five years, making a new fourth trough.
In this article, we explore the possible scenarios for what could be a record move in the US dollar and how traders could potentially take advantage of it. Let's get started!
Why has JP Morgan's FX Volatility Index Spooked the Market?
The Forex volatility index developed by JP Morgan is fairly simple. Its aim is to measure the volatility of Forex options across a basket of major and emerging currencies. Currently, it sits at a five-year low which means the volatility of currency markets is historically quite low.
Even a similar index tracked by Deutsche Bank is sitting at its lowest level in five years. Low interest rates across the world has ramped up demand for equities which has helped lift global stock markets higher but push down currency market volatility. So why is this important?
According to data compiled by Bloomberg, each time the JP Morgan Global FX Volatility Index has been trading close to where it is now, the US dollar (specifically the US Dollar Index Futures Contract), has exploded around 10% over the next six months. However, this is simply a measure of volatility - not direction!
In fact, in 1996 the US dollar surged more than ten per cent, while in 2014 the dollar rose more than 15%. However, the volatility slump in 2007 helped the dollar to drop more than 10%. The key question is what is influencing the US dollar right now? Let's take a look.
The Major Influences on the US Dollar Right Now
One of the biggest influences on the US dollar right now is a change in US Federal Reserve monetary policy. Early this year the Fed spooked the market by shelving plans to raise interest rates this year. The Fed has been the only major central bank to have been increasing interest rates which helped lift the US dollar while pushing down other major currencies like the Euro and Australian dollar.
Another major influence affecting the US dollar is the extreme positioning in the EURUSD currency pair. According to the latest data from the Commodity Futures Trading Commission, short bets on the euro now stand at their highest level since December 2015. While some would take this as a bullish sign for the US dollar and bearish sign for the euro - extreme short positioning in any market is more susceptible to huge price swings to the upside on any positive news announcement.
There is also the uncertainty surrounding US and China trade talks. While Trump has been talking up the progress made in talks, at the beginning of May he reversed his position saying they are still far apart and that negotiations are taking too slow. The market experienced a huge amount of volatility on this announcement.
Currently, the fundamental picture is mixed with both bullish and bearish cases for the US dollar. What do the technical charts say? Let's find out.
How to Trade US Dollar Volatility
One of the currency pairs that is most widely impacted by movements in the US dollar is the EURUSD. This is because these are two of the largest currencies in the world. The long-term chart of the currency pair is also painting an interesting picture for traders:
Source: Admiral Markets MT5 Supreme Edition, EURUSD, Monthly - Data range: from October 1, 1984, to May 6, 2019, accessed on May 6, 2019, at 10:57 pm BST. - Please note: Past performance is not a reliable indicator of future results.
In the screenshot above, it is clear to see the monthly chart of the EURUSD has been held in between two long-term support and resistance levels, denoted by the horizontal support line and descending resistance line, both in black. Currently, price is trading in the middle of the support and resistance levels.
Historically, the market has bounced off these levels so most traders will be looking to trade as the historical price pattern suggests. However, there is a risk that the market could break out of these levels at some point, potentially causing a much bigger move if the JP Morgan Global FX Volatility Index is correct.
While both situations are focused on the long-term, some traders will view lower time frame charts to look for early clues on where the market could go. In any situation, using the exclusive Admiral Markets volatility protection settings could prove to be very useful and can be activated in Trader's Room for Trade.MT4, Zero.MT4 and Trade.MT5 accounts, either live or demo.
With the potential of imminent record-breaking moves, how are you preparing to take advantage?
One of the best ways you can get started is by downloading the MetaTrader 5 trading platform, where you can trade thousands of the world's financial markets using your Admiral Markets live or demo account. Simply click below to get started!
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