Spikes of volatility have appeared in FX markets in recent weeks, prompting speculation that a long period of dormancy in currency options might be coming to an end. However, reports of a forthcoming bonanza could be exaggerated, some analysts say.
The dollar last week took a breather from a 12-week rally, its longest positive move since at least 1971, and the US dollar index, which tracks the greenback against the currencies of six trade partners, fell slightly to 85.91, after reaching 86.75 the previous week, its highest level since June 2010.
The impact of the resurging dollar has caused waves of volatility, with emerging markets currencies, the euro and Antipodean dollars moving out of their ranges. The Australian dollar declined around 7% against its US counterpart in the month to October 7, while the euro hit a two-year low of $1.2571 as it came off its worst quarter since 2010, and the yen has broken out of its 20-month range against the greenback.
“Probably the most impressive move in terms of volatility has been in emerging markets and in Australia, where investors have seen a lot of reasons for the Ozzie to weaken,” says Olivier Korber, Paris-based FX and derivatives strategist at Société Générale. “It didn’t happen for a long time and the market didn’t understand why the Ozzie was so resilient, and then all those expectations were fulfilled in a short time and the options market reaction has been quite spectacular.”
One-month implied volatility on AUD/USD has jumped from between 6% and 6.5% on September 8 to as high as 9.5% in recent sessions, according to SG, as demand for hedging and speculation through options rose.
“The origin of the move in volatility is the rebirth of the dollar and expectations for a Fed exit,” says Korber. “FX has lagged that expectation, which has been apparent in short-term US rates for quite a while, but now there is a decisive move out of the trough in volatility, and I don’t think we are going to go back to those ultra-low levels.”
At-the-money implied volatility on EUR/USD was stuck in a range of 4% to 5% in July and August. However, following Draghi’s speech it rose to as high as 7.7%. Realised volatility also rose sharply and, following the September 4 ECB policy meeting when the bank unexpectedly cut its main refinancing rate and increased asset purchases, the euro dropped to the lowest level in almost 14 months. One-month realised volatility in recent trade was 8.2%, while implied hovered around 7.4%.
“Some participants may be rolling short euro spot positions into options, rather than using the options market to hedge the position,” says Marc Chandler, New York-based global head of currency strategy at Brown Brothers Harriman, in a note. “The premium for euro puts has increased vis a vis calls equally distant from the forward strike (three month 25 delta risk reversals).”
The rise in volatility in FX markets is welcome news for many currency market participants, but traders note it remains subdued relative to other asset classes. The VIX index of S&P500 equity volatility surged to its highest level since February in the past week, in contrast to EUR/USD volatility, which has risen but not as sharply.
The same is true for other FX volatilities; for example the NZD/JPY cross – considered one of the most risky in FX (normally falling sharply in periods of heightened risk aversion) – has seen its volatility spread to the VIX widen on the downside in recent sessions.
One of the reasons for prevarication in FX volatility markets could be continuing uncertainty around Fed plans, analysts say.
“One of the reasons why stocks have sold off is because of central bank uncertainty, as Fed expectations swing almost on a daily basis,” says Kathleen Brooks, London-based research director at forex.com. “Since October 8’s FOMC [Federal Open Market Committee] minutes, the market has started to wonder if the Fed is getting nervous about a strong dollar, which could lead them to push out their rate-hiking plans.”