ETF Securities FX Research:

Martin Arnold Director –FX & Macro Strategist [email protected]

9 February 2016

ETF Securities FX Research: Volatility turnaround to drive asset class returns NOK and GBP to outperform Summary 

Investor uncertainty remains elevated. However, investors differ with consumers, with consumer sentiment on an uptrend, lifted by jobs and low energy prices.



Currency volatility expected to moderate as investors convinced by underlying strength, helping support a ‘risk –on’ environment.



The British Pound has historically had a strong inverse correlation with volatility.



Currencies battered by volatility to turnaround, with Norwegian Krone and British Pound leading the way higher.

While there has been a divergence in recent months between the leading economic indicators and consumer sentiment, there has been strong direct correlation historically. The improving trend in consumer sentiment (buoyed by rising jobs and wages and falling energy prices) suggests that the slowdown in manufacturing and services from survey evidence has the potential to reverse in coming months. We expect that such a development could be the catalyst for a reduction in market volatility as investors become more confident in the solid underlying economic fundamentals.

Volatility elevated

Sentiment divergence

80

Investor uncertainty, which manifests in greater asset return volatility, has been driven primarily by uncertainty surrounding US central bank policy, the softer growth outlook for China, and plunging oil prices. However, investor sentiment stands in stark contrast to consumer sentiment. As a result, there appears to be a fundamental disconnect between returns for cyclical asset classes and the underlying economic fundamentals, particularly in the US. While market participants appear to be focussing on softening metrics like manufacturing and industrial production, consumer sentiment is breaking higher and likely to underpin activity in both the services and manufacturing sectors.

60

Sentiment divergence 80

100

70

80

60

60

50

40

40

20 Developed economy leading economic indicator(lhs)

30

0

Developed economy consumer sentiment index (rhs) -20

50

OIV (lhs)

16

VIX (lhs)

14

FXVIX (rhs)

12 10

40

8

30

6

20

4

10

2

0 Sep 10

0

Sep 11

Sep 12

Sep 13

Sep 14

Sep 15

Source: Bloomberg, ETF Securities

Nonetheless, asset market volatility has been at multi-year highs for many asset classes in 2016. Although volatility has continued to rise in recent weeks for oil (OIV) and for currencies (FXVIX), it has begun to moderate for equities (VIX). During periods of elevated (or depressed volatility), movements tend to be consistent across asset classes. However, one indicator that could be the herald for more market stability is the volatility of volatility. The volatility of volatility has been moderating for all asset classes, indicating that volatility is lessening. This means that the investor uncertainty might be waning and could lead to a reversal of the ‘risk-off’ trend that has been in vogue in 2016.

Jan 90 Nov 90 Sep 91 Jul 92 May 93 Mar 94 Jan 95 Nov 95 Sep 96 Jul 97 May 98 Mar 99 Jan 00 Nov 00 Sep 01 Jul 02 May 03 Mar 04 Jan 05 Nov 05 Sep 06 Jul 07 May 08 Mar 09 Jan 10 Nov 10 Sep 11 Jul 12 May 13 Mar 14 Jan 15

20

18

70


For Investment professional use only, not for public dissemination – Past performance does not guarantee future results.

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ETF Securities Research 2016

Volatility to moderate 180

25

OIV (lhs)

160

VIX (lhs)

140

20

FXVIX (rhs)

120

15

100 80

10

60 40

Norwegian Krone, following the sharp rebound in oil prices. If oil prices stabilise in line with volatility, this could be the beginning of a sustained rise for NOK (and its oil counterpart CAD, which has lagged the oil bounce thus far). Indeed, while it has outperformed in 2015, it is still well below its levels of a year ago, with plenty of upside potential.

Implications for the US Dollar

5

20

Investor optimism over the strength of the US Dollar is beginning to fade ahead of the key March FOMC meeting.

0

Sep 12

Sep 13

Sep 14

Sep 15


Investor positioning

60000

20000

105

0

100

Sep 15

Jan 16

Jan 15

May 15

Sep 14

May 14

Sep 13

Jan 14

Jan 13

May 13

90 Sep 12

-40000 May 12

95 Sep 11

-20000


0% -2% -4% -6%

VIX

JP Morgan Global FX Volatility

Long JPY Short EUR

Long USD Short EUR

Long USD Short EUR

Long CHF Short EUR

Long SEK Short EUR

Long GBP Short EUR

Long CAD Short EUR

Long NOK Short EUR

Long Euro Basket

Long AUD Short EUR

Long NZD Short EUR

-8%


The British Pound has been the worst performing G10 currency, with the exception of the New Zealand Dollar. The poor performance is not surprising as GBP tends to be inversely related to volatility. However, in coming months we expect this weakness to moderate as market volatility gradually fades. 21

1.35 GBP/USD (RHS)

JP Morgan Global FX Volatility (LHS)

19

1.4

17

1.45

15

1.5

13

1.55

11

1.6

9

1.65

7

1.7 1.75 Feb-10

Feb-11

Feb-12

Feb-13

Feb-14

We continue to believe there is modest upside to the US dollar in coming months as the underlying robust economic fundamentals reappear, but then we see a peak as the improving economic backdrop is fully priced into interest rate expectations for the FOMC in 2016.

G10 (per EUR) (%chg) New Zealand Dollar British Pound Australian Dollar United States Dollar Swedish Krona Swiss Franc Canadian Dollar Japanese Y en Danish Krone Norwegian Krone

NZD GBP AUD USD SEK CHF CAD JPY DKK NOK

Year-to-Date -4.41 -4.14 -4.01 -2.82 -2.23 -2.13 -2.08 -0.13 -0.03 0.99

12 Mth -3.78 -2.21 -3.3 2.83 0.34 -5.53 -6.57 2.61 -0.79 -8.57


Volatility weighs on GBP...

5 Feb-09

110

Jan 10

Monthly Data in EUR, From Nov 05 to Jan 16

2%

115

40000

May 10

Falling volatility environment

4%

120

USD Basket Index (rhs)

Jan 11

Certain currencies perform better in high volatility environments while others perform better in low volatility environments. During 2016 thus far, there have been several key currency trends that are worth highlighting as volatility begins to decline to more historical norms. (See relative performance tables below).

125 Net Non-Commerical USD futures positions (lhs)

80000

Sep 10

What does this mean for currencies?

100000

Jan 12

Sep 11

May 11

0 Sep 10

Feb-15


G10 (per GBP) (%chg) New Zealand Dollar Australian Dollar United States Dollar Swedish Krona Swiss Franc Canadian Dollar Japanese Y en Danish Krone Euro Norwegian Krone

NZD AUD USD SEK CHF CAD JPY DKK EUR NOK

Year-to-Date -0.22 0.2 1.45 2.06 2.16 2.21 4.26 4.36 4.38 5.43


The best performing currency by far in 2016, has been the

Investments may go up or down in value and you may lose some or all of the amount invested. Past performance does not guarantee future results.

12 Mth -1.03 -0.54 5.76 3.21 -2.83 -3.9 5.54 2.04 2.81 -5.96

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ETF Securities Research 2016

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