Forex Investment and Currency Trading

Stocks: One of the big reasons to be bullish stocks lately has been the enormous stash of cash on the sidelines, a byproduct of the raging fear in the markets from January to March. But if this massive flood of money is lurking, should we not have seen a big rise in volume as the market broke through the unanimously important 1400 / 1405 level in the S+P? The fact is, volumes on the rally have been pathetic and it seems that the cash on the sidelines is not being aggressively put to work and therefore what we are seeing is more squaring of record short positions, not large-scale real buying of equities. The Dow was up a paltry 30 points Friday after a better-than-expected NFP – a number the
market could easily have taken as an excuse to push the Dow up 200. That says to us that this rally in stocks is tired.

This fits with the idea that the USDJPY rally is due for a correction as well as we are now 1,000 points off the March 17 lows and 1-month volatility is back near 10. Since the subprime story really hit the markets in July 2007, one necessary condition for an aggressive sell-off in USD/JPY has been that 1-month vol is down around 10. This perhaps is because there is a required amount of complacency in vol world before you can see an aggressive drop in spot. We have reached that level of complacency again.

Take a look at the following chart, which shows USD/JPY (black) vs. 1-month yen volatility (red). You can see there is a strong inverse relationship. But look at each time the red line (left axis) gets to around 10. Spot tends to peak and sell off aggressively in the days/weeks following. The obvious counterargument to this is you think we are in for a dead summer and 1-month vol will keep falling towards 7 or 8. With the market now long on the break of 105.00 and complacency very high, short USD/JPY here (105.25) with a stop at 105.85 looking for a correction to 103.45 / 104.30 band. The
aggressive rally in oil and the subsequent stabilization in gold is further reason to be dollar-bearish and support the view of lower USD/JPY.