Traders Lament Death of FX Volatility as Torpor Tanks Returns
(Bloomberg) -- While most traders would hardly describe 2017 as “dull” -- what with the nuclear brinkmanship, disintegration of global trade alliances and numerous presidential tweet storms -- one thing has remained conspicuously absent: volatility.
For FX-focused funds, the lack of price swings has stung particularly hard. The Citi Parker Global Currency Manager Index, which tracks the performance of 14 FX programs representing nine distinct investment styles, has declined almost 4 percent this year, the most since 2011.
Extreme fluctuations, the kind that create opportunities for profit, have been fewer and farther between this year as markets from stocks to bonds to currencies have largely shrugged off the chaos of U.S. President Donald Trump’s first year in office and electoral uncertainty in Europe amid well-telegraphed central bank policy globally. A JPMorgan Chase & Co. gauge of three-month implied option volatility in global foreign-exchange rates has slumped to near the lowest since 2014 as traders see little on the horizon to wake markets from their torpor.
Three of the most frequently traded currencies -- the dollar, the euro and the pound -- “are characterized by somewhat strange political backdrops that are just creating confusion in the market and creating a little bit of a wait-and-see landscape,” said Darren Wolf, head of hedge-fund solutions for the Americas at Aberdeen Standard Investments, which oversees about $764 billion. “This wait-and-see perspective means people are just not taking a lot of risk.”
While geopolitical tensions, from missile launches by North Korea to contentious elections in Europe, have provided plenty of tradable headlines, FX managers have largely looked past such risks this year. Meanwhile, as major central banks, particularly the Federal Reserve and the European Central Bank, plan to dial back stimulus, moves have been well-communicated and measured, keeping market gyrations in check.
Implied volatility on three-month options for the euro has slid to 6.86 percent, near levels not seen since 2014, while dollar-yen volatility has fallen to 7.90 percent. Bank of America Corp.’s MOVE Index, which is derived from over-the-counter options on Treasuries maturing in 2 to 30 years, dropped to 43.97 on Nov. 8, the lowest since the data began in 1988, and is currently trading at 47.49.
“The key to volatility in global markets, the epicenter, is bond volatility,” said Alan Ruskin, global co-head of foreign-exchange research at Deutsche Bank AG. “Yields have been suppressed significantly either because of quantitative easing and/or negative rates. Inflation has been on the soft side as well. If any of those things give way, then you start to inject volatility into the bond market and then it will transmit itself” outward.
FX strategies also suffered as the year’s most popular trades failed to pan out. Hedge funds started 2017 fiercely bullish on the dollar as then-President-Elect Donald Trump, backed by a Republican Congress, promised a surge in fiscal stimulus. Dollar longs held by large speculators reached their highest in more than a year in January, according to Commodity Futures Trading Commission data.
But as Trump’s pro-growth policy agenda stalled, so too did the greenback. The Bloomberg Dollar Spot Index slid as much as 11 percent, and is poised for its first decline in five years.
“Certainly the low-volatility environment has been a problem, but people were also just caught on the wrong side of that dollar trade coming into the year,” Aberdeen’s Wolf said. “We still are in an environment that’s characterized by extreme accommodation relative to historical standards.”
Among the most common strategies foreign-exchange traders use to generate profit, momentum investing is having its worst year since 2012, while carry returns have slid 5.4 percent year-to-date. Even fair value’s 2.4 percent gain would be its lowest in five years, according to Deutsche Bank models.
Yet as central banks begin to normalize monetary policy amid improving global fundamentals, regime shifts could provide a pathway toward greater volatility, according to Thierry Wizman, a New York-based strategist at Macquarie Group Ltd. In the U.S., both chambers of Congress have approved separate proposals that, if reconciled, would overhaul the tax code. Trump is also expected to release a long-awaited infrastructure plan in January, a senior administration official said last week.
“There’s been convergence in global growth rates and people are expecting a synchronized global recovery, so that has tended to reduce FX volatility," Wizman said. "That could change in 2018. The U.S. could have an important stimulus potentially with this tax reform."
An economy firing on all cylinders could prompt the Federal Reserve to be more hawkish than anticipated, which might beget more volatility. The same goes for the euro zone. Otherwise, investors will be waiting for a new segment of the cycle before volatility returns.
The pattern in the markets for the last several years has been to shrug off geopolitical risk, Wizman said. “Sometimes the market reacts to it, but to the extent it doesn’t affect the global economies,” traders just forget about it.
©2017 Bloomberg L.P.