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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