Are we entering a volatile period on the FX markets?

Blog
No Comments

Turmoil in the World Cup may be catching the headlines but what is happening in the FX market? The received wisdom is that a lack of volatility is bad news and yet that has been the case in a period of low interest rates around the world. A recent surge in the US Dollar would normally be a signpost of increased activity. But that has yet to materialise.

 

The anticipation of extra volatility and the opening of pricing gaps – creating anomalies to increase hedging opportunities and cross-border activity – has been quashed of late. Low interest rates and central banks’ penchant for quantitative easing have disrupted the cues which the markets take from global economic policy.

 

FX market experts are confident that they are about to turn the corner, but they are looking to be informed by trends in the third quarter of 2018.

 

Interest rate

 

The reality is that there seems to be little sign of this. The markets are still reliant on daily movement and spot prices and, from that, they try to gauge the implied swing which drives traders’ options in perceived volatility.

 

There may be something in the air, however, with the Bank of England suggesting a potential interest hike in August and the US Fed may be following suit.

 

The dampener may be the European Central Bank’s position. The surge in Euro volatility at the beginning of the year has collapsed to levels not seen since 2014. Dealers remain unconvinced by the perk in the US dollar even though it is reflecting surges from 2015 and 2016 which sparked activity on the exchanges.

 

The question dealers are looking at is whether this is a structural or cyclical move. Analysts believe that quiet currency markets are a sign of the latter rather than the former. A structural shift in the market would excite dealers and the fear amongst them is that the recent moves in the market are reflective of an unwinding of record bets against the greenback.

 

For an accurate analysis of the FX market, it is always key to look at other asset classes as the world’s bond and share markets reflect currency levels.

 

The major markets still look strong and resilient, and swings in oil and metals continue to outperform currencies.

 

Cautious approach

 

It should be remembered, however, that the foreign exchange market averages US$5tr in trades each day and this volume should trigger volatility. The current cautious approach from traders cannot last forever. Even so, the easing by central banks continues to subdue the market, and here is the key.

 

The three major central banks pumped in US$2tr last year and that has had an enormous impact on FX exchanges and the market as a whole. But what of the future?

 

These injections into the market are predicted to fall by 25% during 2019 and that could spark volatility in the currency markets. Currently, traders are looking at premiums on selling options, safe in the knowledge that central banks will provide a backstop, but that may be about to change.

 

The fall in activity has meant that large speculators have stepped away from the market. They are now looking at hedging against a currency rather than taking a punt on the Yen, for example. The small fluctuations we currently see are a reflection of this. The market seems to have focused on interest rates and ignored other influences such as inflation and a collapse of the synchronised growth in global economies.

 

The potential trade war apparently envisaged by the current Trump administration could prove to be the shaker which this supine cocktail of events needs to spark the FX market.

 

Volatility is the key and it is sure to return to the FX market. Traders and investors will have to keep an eye on events which could be sparked by political uncertainty in the Euro zone, not only involving Brexit but also issues within the bloc caused by Italy and Eastern Europe.

 

Add this to a potential global trade war and the FX market is certain to be interesting and one which will be worth following closely in the remainder of 2018.

 

Simon Lynch is the owner of Treasury Talent.

Treasury Talent is a specialist treasury talent, recruitment and search provider solely focussed on the treasury market with offices in Sydney covering Australia, Singapore covering Asia, and San Francisco covering California and the USA. To make contact simon@treasurytalent.net

Leave a Reply

Your email address will not be published. Required fields are marked *

Fill out this field
Fill out this field
Please enter a valid email address.
You need to agree with the terms to proceed

Menu