The emerging trend: long the USD and VIX

After the 24 hour volatility mayhem that saw the FOMC board meeting, Scottish independence vote and Alibaba IPO, today is likely to see the dust settling and a little more calm in the market.

Source: Bloomberg

All three events went the way of the favouring position. There was no major change in the FOMC’s standing. Scotland voted no to independence And Alibaba got away with a bang. Being net long the USD, GBP and Alibaba has certainly been the correct strategy and is likely to remain so in the main.

The question now is, what happens from here as the market looks to the final quarter of this year and the first quarter of the next. On the trend that is emerging, being long the USD and long the VIX looks advantageous.

The strength in the USD over the past four weeks is a telling trade. It shows the market has finally decided to shift its positioning to net long, having held the line for most of the year as it awaited clearer signs the FOMC is shifting its stand and expectations around the Fed funds rates.

The lift in the dots after rising rate expectations at the end of Q4 2015 and Q4 2016 has confirmed the theory around the USD, and the rise in the dots will only strengthen the idea the Fed is going to have to raise rates at least five times to reach the 1.375% estimate. This means they may come sooner rather than later. The net long USD is not only on the rise, but will be the trade of the next six months as anticipations of rate rises accumulate.

What is also clear from the FOMC meeting is that, despite its best efforts to moderate the markets’ anticipations, the mixed read from the statement on Thursday has only led to a rise in volatility.

The VIX index is in for sharp and violent jumps as the FOMC navigates its increases to monetary policy. It will create pockets of increased uncertainty – and that is only going to pump up the VIX. Net long the VIX is also a trade to watch over the coming six months as the FOMC tries to mitigate the uncertainty.

Ahead of the Australian open

This trade is also going to spill over into the Australian market. The collapse in the AUD is something the RBA has been waiting for – it continued to complain about its elevation since August last year. The falling AUD means that international investors are going to close profitable total return trades and repatriate funds. This increases the likelihood of equity selling, putting upward pressure on the Australian volatility as total returns are squeezed.

This trade will take a few weeks to be shaken out and it will create opportunities come the end of the year. However, in the interim the current slide in the ASX looks to be holding true and is likely to see it testing 5350 before the oversold trade is refilled.

We’re currently calling the ASX 200 down 20 points to 5412 after some lacklustre trading in the US on Friday night. Iron ore collapsed once more and is now back at 2008 lows of US$81.70 a tonne. Very cyclical material plays will feel further pain. The bounce on Thursday and Friday looked like a technical trade and, having crossed into oversold territory, was expected to snap back. However, the trend in the ASX is certainly on the downside until commodities find a floor and the international investor shake out is completed.

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