Volatility and the AUD/JPY Setting Up For Potential Market Correc…

In this weekend update, we take a closer look at volatility and the VIX.

We have seen a very bullish equity market from the elections until today. We have seen bullish moves in equities to the point that the NASDAQ has not seen 2 bearish days in a row in 53 days, 30 out of 37 days have closed higher. While equities have moved higher, the VIX has not only remained low but has fallen from 14.07 to 9.97. The high risk appetites has kept volatility and risk premiums low.

During the past 2 trading weeks, volatility has edged higher and equities have also moved higher. The VIX is a measure of put all ratios or an indicator of hedging using options. The past to week rising volatility and rising equities can be seen as a fundamental divergence. It can also be considered to be an indication that despite rising equity prices, some investors are starting to hedge and buy protective puts.

We have further indication that we are seeing hedging is one of our favorite correlations between equities and the AUD/JPY. The yen is sold short with more than 20 years of zero percent interest. When uncertainty starts to creep into the global markets, the short yen positions are covered which means that the yen strengthens and the AUD/JPY pair falls. Nearly 2 weeks ago, the AUD/JPY found a high and has sold off more than 200 pips dropping to a 2 week low. The selloff in this pair, despite rising equities and rising gold prices (correlated to the Australian dollar) could be an indication that we are in overbought territory in equities and poised for a pull back of 3% in equities to match the move in the AUD/JPY.

This pair has a correlation to equities and the relationship is not one of causation so we will want to see price confirm in a drop of equities and even better we would like to see the AUD/JPY close below 85 and equities drop more than 1% with volume otherwise we will expect the AUD/JPY to bounce and equities to continue higher.