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By Kathy Lien, Chief Strategist of DailyFX.com
US dollar: Volatility continues to rise as equities see another roller coaster ride
August is typically a month where most people expect quiet summer ranges. However this year, even those who have the luxury of enjoying the entire month off may not be sitting pretty.
Volatility has rocked the markets and no asset has been spared including stocks, bonds and oil prices. The Dow went from being up close to 100 points to down over 70 before settling back up 150 points. Oil prices also hit fresh all time highs before reversing sharply.
This rollercoaster price action pushed the Chicago Board Options Exchanges' market volatility index (VIX) to a one year high today. Although it later retraced, the last time we saw the VIX at that level was back in 2006, which was also when we saw the biggest case of carry trade liquidation in 20 years.
The drawdown in carry trades at the time was 13 per cent, double what we have seen so far. There is no real explanation for the late afternoon recovery in US equities. Instead, hedge funds have reported more losses. Bear Stearns announced today that it has blocked withdrawals from a third hedge fund and there were also reports that Caxton Associates was being forced to cut exposure due to margin calls from JPMorgan Chase and Goldman Sachs.
As for economic data, ADP reported much weaker private sector employment, Challenger reported more layoffs while manufacturing growth slowed nationally in July. Even though the ADP number was quite bad, it overshot private sector employment by 50,000 last month, which suggests that the drop in July could simply be a reversal.
The one piece of good news was the rise in pending home sales. After falling by 3.7 per cent in May, sales increased by five per cent to a three year high. Unfortunately sales were still below year ago levels and was offset by the fact that mortgage approvals hit a five month low, indicating that the housing market has yet to stabilise.
There were also rumours today that Beazer homes may have to report bankruptcy. Although denied, we would not be surprised if bankruptcies become the trend. In the meantime, any rebound in the Dow and carry trades will probably have a difficult time recovering even half of its recent losses.
British pound rallies into Bank of England rate decision
The Bank of England (BoE) is expected to leave interest rates on hold tomorrow, but the rally in the British pound over the past few days suggests that some traders may be holding out for a surprise move.
Compared to the rest of the world, the UK economy is certainly standing on stronger footing. Today, manufacturing PMI surged to a three year high, which comes in sharp contrast to the deterioration in the US ISM index. Output prices hit the highest level in 15 years, indicating that inflation is still a big concern while employment rose to a three year high.
Even if it does not raise rates, this suggests that Bank of England Governor Mervyn King will continue to hold onto his hawkish bias when he delivers their Quarterly Inflation report next week.
European Central Bank: No surprise press conference expected
Despite the volatility in the rest of the foreign exchange market, the euro traded in a tight range. Slower manufacturing sector growth in Germany and France did not stop the final Eurozone PMI numbers from coming out stronger than expected.
Kathy Lien, Chief Strategist, Daily FX
