Currencies Are Ready to Swing as Seasonality, Policy Join Forces
Currencies Are Ready to Swing as Seasonality, Policy Join Forces
(Bloomberg) -- Trading in the calm currency market may be about to get rough.
Seasonality tends to push up volatility in August amid reduced liquidity. Traders are already seeking protection ahead of key central bank gatherings in September, driving currency hedging costs sharply higher.
In the next two months, investors will be awaiting clarity on the policy path for the Federal Reserve, Bank of England and European Central Bank. At the same time, they are likely to get a better sense of the economic impact of coronavirus variants and whether they’re justified in paring expectations for tightening.
“The topic of Fed tapering will be high on the agenda,” said Jane Foley, head of foreign-exchange strategy at Rabobank. “This factor, combined with news on the delta variant and mixed with thinned holiday conditions, suggests there is a good recipe for higher volatility.”
Repricing Risk
The repricing already seen in short-term volatility contracts in major currencies is telling. Even though traders don’t expect policy shifts, the possibility of changes in forward guidance in coming months is enough to lift volatility.
Read More: Hawkish Fed Bets Axed as Traders Confront Tumbling Bond Yields
Two-week options in the pound, which capture both the Fed and BOE’s upcoming meetings, rose to the highest level since early May -- a sharp contrast to a 16-month low seen just a week ago.
Outsized Swings
Beyond monetary policy expectations, renewed pandemic concerns are also raising the cost of hedging. This is most evident in the Australian dollar-Japanese yen pair, a widely used risk proxy given the Aussie’s ties to global growth and the yen’s perceived safety.
The pair’s so-called 10-delta three-month butterfly has risen to the highest since late May, showing investors are looking for protection from outsized swings in the months ahead. The Aussie has whipsawed versus the yen this week, trading at 81.487 as of 7:48 a.m. in New York, a 2.1% recovery from a five-month low seen on Tuesday.
Rabobank’s Foley said volatility in the Australian dollar and New Zealand dollar versus the greenback could be “interesting” in the months ahead.
On top of these metrics, market color also points to upside risks in volatility. Hedge funds are adding long gamma exposure into the Jackson Hole symposium in late August and the ECB’s September meeting, according to Europe-based traders who asked not to be identified because they aren’t authorized to speak publicly.
- NOTE: Vassilis Karamanis is an FX and rates strategist who writes for Bloomberg. The observations he makes are his own and are not intended as investment advice
©2021 Bloomberg L.P.