Market insights

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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