Currencies and precious metal

Recent rise in FX volatility likely linked to the renminbi

Luc Luyet, Currencies Strategist

Recent rise in FX volatility likely linked to the renminbi

Despite elevated global uncertainty, notably linked to trade tensions, currency volatility has remained below its long-term average. It was even close to its lowest point in the past 17 years in mid-year. However, volatility has climbed since July.

The volatility decline at the start of September came at the same time as renewed renminbi strengthening versus the USD (and receding con­cerns of a significant depreciation in the renminbi). While some temporary trade truce cannot be ruled out, our view remains that fundamental issues (such as intellectual property) make a comprehensive deal between the US and China unlikely. Consequently, trade tensions are likely to continue to rumble on in the background, which may support volatility in the FX mar­ket should the renminbi prove less sta­ble again.

Besides trade tensions, there may be other reasons for higher volatility in the (not so near) future. With fresh asset-purchase programmes and neg­ative interest rates, central banks have been having a significant impact on the FX market. At the same time, central banks are now near the limit of what they can do, and with the risk of further mod­eration in global economic growth, new answers may have to be found to support the economic outlook.

Another source of potential vola­tility may stem from the US presiden­tial elections. Trump may well end up running against a Democratic can­didate at the very left of the party’s spectrum. If this is the case, whether the result is a Democratic president with a progressive policy agenda or a Trump unconstrained by re-election concerns, markets will potentially face a significant shift from current US policy.

Overall, volatility in the FX market largely means volatility of the EUR/USD rate, which is the most traded exchange rate (24.0% of all daily aver­age turnover, according to the Bank of International Settlements’ tri­ennial survey). With the European Central Bank’s September easing pack­age now behind us and an extension to the Brexit 31 October deadline look­ing possible at time of writing, there appears to be reduced scope for an increase in volatility in the short term.

Although EUR/USD volatility may stay below its long-term average in the near term, volatility could be higher elsewhere. Obviously, volatility in sterling (GBP/USD represents 9.6% of all daily average turnover) is likely to remain elevated around Brexit-related uncertainty. To a lesser extent, we see scope for higher volatility in the Japanese yen (USD/JPY represents 17.8% of all daily average turnover), which is highly sensitive to the health of the global economy.

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