Dollar surge raises hopes for volatile FX
The US dollar's unexpected surge over the past month is encouraging currency traders to pray for a return of lucrative but long-dormant price volatility on the main foreign exchanges, although early signs on that are strangely subdued.
Extra volatility - how much markets fluctuate up or down - opens up pricing gaps and anomalies that give traders more opportunities to make money, brokers more volume, and seeds greater demand for hedging services from multinational companies and cross-border investors.
But recent years have seen big currency swings evaporate as record-low interest rates converged toward zero and central bank money-printing weakened the cues exchange rates take from monetary policy trends and economic divergence.
That in turn has hammered profits at hedge funds and banks' FX trading divisions, though some are asking whether the dollar's blistering 5 percent rally since mid-April will mark a turn for vol, as known in market parlance.
“FX is back to life. We will have to wait through a few more months of low volatility but the time will come and it is getting more attractive,” said Andreas Koenig, head of global FX at Amundi Asset Management.
So far there is little sign of this. Markets broadly look at two gauges of currency volatility — a daily swing in actual spot prices and an implied gauge derived from options markets on what traders expect volatility to be.
Three-month implied volatility in the euro has completely unwound its February surge and is heading back below 6, levels not seen since 2014, while actual currency market swings remain comparatively elevated.
Realised moves in the euro remain elevated with daily volatility creeping up to around 5.5 and nearly doubling from the start of the year, a function of the dollar's rally that has taken currency markets by surprise.
And there lies the rub. Despite the dollar's rise, which has drawn comparisons with earlier cycles of a surging dollar and increased volatility in early 2015 and late 2016, traders remain sceptical this move signals the return to more volatile markets.
“It doesn't feel at this stage like the beginning of a larger structural move higher,” said Richard Bibbey, HSBC's global head of FX cash trading, while adding that quiet currency markets were a “cyclical” rather than structural issue.
There are many in the market who say the recent dollar spike may be temporary, because it has been caused by speculators unwinding record bets against the greenback rather than a structural shift in the global economy.
What about volatility in other asset classes? US Treasury bond volatility is back towards record lows. In contrast, the S&P 500's volatility in the first 90 trading days of 2018 was the highest start to a year since 2009, while price swings of crude oil and metals are far higher than for the dollar.
Even major events in the $5 trillion-a-day foreign exchange markets, still the world's biggest, in the last three years including the Brexit referendum and the removal of the cap on the Swiss franc, have failed to inject meaningful volatility.
Broader FX volatility indicators also remain subdued - Deutsche Bank's Currencies Volatility Index has ticked higher but remains near January's record lows, thanks to the anaesthetising effect on markets from unconventional easing pursued by global central banks.
JP Morgan said the world's top three central banks pumped in a record $2 trillion last year as part of its policy support to markets. This year, injections are set to drop to a quarter of that amount, followed by net withdrawals from 2019.