Currency Traders Brace for Rocky Path to Central Bank Meetings
Currency Traders Brace for Rocky Path to Central Bank Meetings
(Bloomberg) -- Foreign-exchange traders are betting on bigger price swings as markets attempt to second-guess the conclusions of a clutch of central bank meetings toward the end of the year.
The Federal Reserve, European Central Bank and the Bank of England will give monetary policy decisions within a mere 24 hours come mid-December. The cost of hedging against volatility in the euro against the dollar over the next month has already climbed the most this week since the pandemic struck in March 2020, and options markets suggest the moves are far from over.
Hotter-than-expected inflation and more positive retail sales in the U.S. have spurred a gauge of the dollar’s strength to hit a one-year-high as traders anticipate the Fed embarking on a faster pace of tightening. While gauges of price swings remain well below historical peaks, one-month volatility in the greenback against the yen has climbed to the highest in a year, and for the pound to the most since March.
“It’s likely that we see FX volatility shifting higher in the near-term, in line with the uptick in bond market volatility that we’ve seen in recent months,” said Viraj Patel, global macro strategist at Vanda Research. “Given the multi-speed recoveries taking place in the G-10, the theme of economic and policy divergence is likely to see FX crosses breaking out of their contained post-Covid ranges.”
Signs of rapidly recovering economies are unleashing swings across markets as central banks may be forced to act quicker than they have indicated. And there’s no sign of this ending in the near-term, with each data release and policy maker speech a potential catalyst for further price moves.
The yen, pound and euro have been knocked out of their well-worn trading ranges. A sharp rise in Treasury yields and U.S. retail sales propelled the yen to its weakest in four years against the dollar Tuesday, while the euro slumped to fresh 16-month lows Wednesday. The pound is hovering near its lowest this year.
Other factors are also creating uncertainty for traders. Rising Covid-19 infections in Europe, a burgeoning energy crisis and renewed Brexit tensions are weighing on the market’s calculations.
Options suggest markets are poised for further rallies in the dollar. One-month risk reversals in euro-dollar, a gauge of positioning and sentiment, traded Wednesday at a 67-basis-point premium in favor of selling the common currency, a level unseen since May 2020. Options sentiment in the pound is also close to its most bearish since December 2020. In dollar-yen, traders are eyeing the next psychological level of 115.
“I would expect the current bout of FX volatility to be more pronounced and sustained if measures of U.S. long-term inflation expectations become less anchored around the Fed’s long-term goal,” said Elias Haddad, a senior currency strategist at the Commonwealth Bank of Australia. Measures of volatility still remain below long-term averages but there was a “non-negligible risk” of U.S. inflation expectations getting out of hand, he added.
Vanda’s Patel argues that the certainty promised by central banks in December should see price swings begin to calm in the new year, given the ECB is expected to sketch out further detail on its post-pandemic bond purchases and the BOE is seen sating market bets on an interest-rate hike. Traders are close to pricing in a 15-basis-points increase for the Dec. 16 meeting. That day will also see policy decisions by Switzerland, Norway and Turkey, among others.
“When we’re in a tightening cycle itself, and usually with good forward guidance, the uncertainty around policy fades,” said Patel.
Still, the inflation backdrop could open the opportunity for a “really explosive rise in volatility, across assets” if central banks fall behind in tackling rising prices, according to Steven Barrow, head of currency strategy at Standard Bank Group.
“There’s a few indicators out there that we are moving away from a very low volatility environment, including in currencies,” said Barrow. “It’s just a question of what follows -- whether it’s something really quite substantially higher, or whether it’s just a slow drift higher.”
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