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MACRO VIEW
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Trading Around Uncertainty By Amelia Bourdeau
ome financial media experts say that all trading and investing is uncertain by nature. Therefore, why should uncertainty in the markets matter? Well, while there’s some truth to this sentiment, it’s too simplistic. Specific types of uncertainty can directly affect market conditions. While they’re not always easy to anticipate, traders can remain vigilant to help mitigate them. External shocks are unexpected changes or announcements that impact the economy and financial markets and originate from outside of them. Recent examples include President Trump’s trade war tweets. He announced tariffs via Twitter (TWTR) on Chinese and Mexican goods on May 5 and May 30, respectively, blindsiding market participants. On June 7, Trump announced that Mexico tariffs were suspended. External shocks in the form of announcements outside of presidential tweets are known on trading floors as “headline bombs.” Recently, European Central Bank (ECB) President Mario Draghi delivered an external shock—on June 18 he made dovish comments that suddenly sent the euro lower versus the U.S. dollar. Events with binary outcomes also heighten market tension and raise volatility around the event. Examples include the June 23, 2016 Brexit referendum and the June 2019 Federal Reserve Board meeting. The Brexit referendum was a vote on whether the UK would stay in the European Union or leave. The stakes were high, and the exit polls made it
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clear that the result would be close. The vote to leave the EU surprised financial markets. In the days following the outcome, the British pound/ U.S. dollar currency pair one-month implied volatility spiked to above 32; the VIX Index spiked to 26.7; and the British pound fell 11% versus the U.S. dollar. The prospect of rate cuts from the Federal Reserve at each meeting near-term is also an example of event risk with a binary outcome. The third type of uncertainty is prolonged uncertainty, which wears down financial markets. Market sentiment starts to sour over time and can begin to influence the real economy through lower confidence among
consumers and businesses. Equity market losses can reduce household wealth and consumer spending, and worsening business sentiment can cause a retrenchment in business investment and hiring. It’s more than three years since the UK voted to leave the EU, and still the it remains in the union without an arrangement to leave. The risk of a “hard” or no deal exit that had seemingly been removed in April is back on the table. GBP/USD has not returned to pre-referendum levels. The Bank of England (BoE) in its June 2019 monetary policy statement said, “Recent UK data have been volatile, in large part due to Brexit-related
Traders need an event risk roadmap
Presidential Tweet Storms Cause Market Volatility External shocks are unexpected changes or announcements that affect the economy and financial markets even though they originate outside them. Recent examples include trade war and tariff tweets by President Donald Trump.