After Volatile Week, Australian Dollar and Japanese Yen May Range

[B]Implied volatility is one of the most tried and true methods for objectively measuring expected volatility in the spot market. Derived from currency options with different maturities, implied volatilities are used to help predict potential movements in the spot market and is one of the most popular strategies of systems traders and other professional hedge funds. [/B]

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[B]EURUSD
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Euro implieds shot higher above the previous week?s print as the underlying currency proceeded to break down through key support at 1.3500. The quick and volatile decline helped to boost the longer term gauge to 7.45 percent compared to 5.78 percent seen last week. Subsequently, short-long differentials were boosted by a jump higher in short term components, kicking the overall spread higher to trade 55 basis points wide. Although at extreme levels, trend continuation is favored in this instance as the underlying volatility has plenty of room to move higher. Incidentally, last time such levels were reached, a reversal shortly followed as implieds peaked out.

[B]GBPUSD
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Sterling implieds additionally moved higher over the course of the week, running at a slightly faster pace compared to Euro implieds. Longer term components rallied to 8.05 percent as the spread narrowed to 70 basis points wide compared to the 78 basis point spread last week. With activity bursting at the seams for most of the week, and vol levels where they are, our model suggests consolidation is in the near future for the pound. A reversion back in the longer term vol would all but confirm the notion, as comparisons are being made to earlier in the year.

[B]USDJPY[/B]

Japanese yen implieds skyrocketed, breaking our range assessment last week as the price action plummeted through support at the 119.00 to trade lower at 117.28 at the time of writing. Now at far reaching extremes of 12 percent, the longer term component is more than set for a retracement as the short-long differential remains pretty much unchanged from last week?s print. For the record, the spread is now trading 107 bps wide compared to a wider 110 last week. Ultimately, we revert back to our range environment forecast as vols have reached far beyond recent activity

[B]USDCAD
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The underlying currency broke through our range assessment as the price action penetrated topside resistance at 1.0700. However, the expectation remains that the 1.0800 test will prove to be a formidable barrier for the underlying currency, maintaining our range view, as volatilities have reached record levels in the pair. Previously trading at 8.50 percent last week, the longer term measure now trades significantly higher at 10.50, ready for a pullback on inactivity. The spread has also widened to extremes with the short-long ratio widening to 125 basis points.

[B]AUDUSD
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In similar fashion to the Canadian dollar, the Australian dollar implied measure skyrocketed during the week to trade significantly higher than the previous week?s print. Previously trading at 9.25 percent, the longer term component is trading at 12.35 percent, as the short long differential widened to 190 basis points. The previous week?s spread was considerably narrower at 55 basis points. As a result, with vols at such high levels, forecasts remain for a range bound scenario. However, the notion would be put into definitive jeopardy should the underlying currency break the 0.8200 support to the downside.

[B]At its most fundamental, the basic and intuitive interpretation of this implied data is often the most telling for traders. Taken alone, a steady rise in the longer-term implied volatility ([/B][B]the red line[/B][B]) is indicative of a strengthening trend; while inversely, a decline often reveals that a period of range or consolidation in spot is ahead or already in place. Additionally, the histogram or spread between the shorter and longer-term implied volatilities ([/B][B]the blue colored bars[/B][B]) tells a different perspective. As the histogram rises, volatility is expected to pick up faster in the near future relative to the longer-term range. Ultimately, this increases the probability of a breakout scenario in the underlying currency.
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[I]-Richard Lee, Currency Strategist[/I]