Forex
Crushed FX volatility as dollar, finally, subsides: Mike Dolan
© Reuters. FILE PHOTO: The Federal Reserve building in Washington, U.S., January 26, 2022. REUTERS/Joshua Roberts
By Mike Dolan
LONDON (Reuters) -If you were looking for a klaxon to mark the end of the interest rate cycle, a crushing of currency market volatility rings loudly.
Deutsche Bank’s CVIX – the currency market’s version of Wall St’s “fear index” of stock volatility and a weighted average of implied “vol” in nine major pairings – has basically imploded.
Subdued since mid-year, the CVIX took another sharp leg lower this month and hit its lowest since mid-February 2022 – just before Russia’s invasion of Ukraine and the first of the U.S. Federal Reserve’s severe five-percentage-point-plus rate rise campaign that March.
The index – where the dominant weightings of 3-month implied vol in euro/dollar and dollar/yen exchange rates account for more than 50% – is now exactly half the peaks of September last year and some 1.5 points below its historic average.
On the face of it the subsidence of volatility marks the end of “King Dollar’s” latest turbulent rule as Fed tightening ceases and easing speculation now lies ahead.
By driving short-term dollar cash rates and U.S. bond yields higher over the past 20 months, the Fed basically sucked cash from the wider investment world and supercharged dollar exchange rates everywhere. Now that it looks done, the buck’s finally on the back foot – plumbing levels not seen since August.
In what ING strategists Chris Turner and Francesco Pesole describe as the dollar’s “long goodbye” – 2024 looks set to for a persistent, trending bear market for the greenback that in itself will sap volatility as risk markets reflate on the back of central bank easing hopes.
“To speak of ‘reflationary’ policy right now seems criminal – but the Fed has a dual mandate, and if inflation is coming under control through 2024 it can cut rates to ameliorate the impact on the labour force,” the ING team wrote, adding commodity currencies within the G10 were a favourite for 2024.
With implied volatility directionally biased, the and the CVIX are typically well correlated and both peaked in tandem in same month of September last year.
That bias is mainly due to the disruptive aspect of dollar strength – which adds to economic, trade and financial stress around the world via inflation of commodity import prices as well as pressuring dollar-denominated debts in many emerging nations.
That sensitivity, in turn, creates friction and often leading to extreme more extreme monetary policies or even open market intervention to push back – and making a sharp dollar ascent more noisy along the way.
The flipside is more serene for the same reasons in reverse.
‘NORTHWEST PASSAGE’
Nowhere is that clearer than in Japan, where Fed tightening met a persistent easy money and yield capping policy at the Bank of Japan, sank the yen to 33-year lows and drew at least one bout of intervention as the government and BOJ attempted to draw line under the yen as the dollar powered through 150 yen.
But with peak Fed rates meeting trough BOJ ones – and both at least leaning in opposite directions next year, then dollar/yen is finally recoiling in earnest and the two-point premium on dollar/yen over euro/dollar implied vol is dissipating too.
For the euro and sterling, the damage of the dollar rise was ameliorated by the parallel tightening at the European Central Bank and Bank of England. And a Fed pivot is most likely to be matched or even pre-empted by them on the downside.
While three-month U.S.-Japan interest rate differentials are their widest since 2000 and still at those peaks, U.S.-German and U.S.-British equivalent rate gaps never topped 2018 highs and are both falling again.
And while a Fed rate cut is now priced into futures by June, so too is a BOE cut – and an ECB ease is baked into money markets as soon as April.
Not much wiggle room for relative currency trades then and volatility is further contained.
And of course these moves have a habit of feeding off each other, not least in how a drop in implied vol feeds carry trades to higher interest rate currencies – not only within the G10 space, but to emerging markets and beyond and reversing the Fed vacuum cleaner of the past two years.
As the ING team point out, the yen would typically suffer in that regime too as it typically acts as cheapest funding currency. But a likely BoJ policy shift cuts across that.
To be sure, the waiting game could see some stasis re-emerge. UBS Global Wealth Management’s Solita Marcelli thinks this week’s slide may be “overdone” while Fed thinking becomes clearer – though selling dollar rallies probably makes sense in the interim.
But the abrasive resurgence of U.S. Treasury yields through October – as a “term premium” on Treasuries resurfaced due to worries about fiscal policy stasis and rising debt levels – may well have kept the dollar higher than volatility levels would otherwise have suggested over the past two months.
And so with yields on the wane again and the term premium now slipping back into negative territory after just two months, there may be a case for dollar weakness to play catch up.
The alternative take is that the dollar’s not done yet and may not give the ghost until the Spring.
Morgan Stanley thinks the DXY index could rebound up to 8% from here to some 111 before finally falling back later in 2024. The argument is that near-term direction remains foggy as rate differentials likely continue to favour the buck through the first half of the year while growth and geopolitical risks support keeping a defensive stance in dollar cash.
“Much like the Northwest Passage in winter, the pathway toward a weaker dollar this winter is narrow, cloudy, and fraught with risk,” Matthew Hornbach and team told clients this weekend.
And yet if vol is anything to go by, the clear water is already in sight.
The opinions expressed here are those of the author, a columnist for Reuters
By Chuck Mikolajczak
NEW YORK (Reuters) -The dollar edged higher on Tuesday in thin holiday trading as the expected slower path of interest rate cuts from the U.S. Federal Reserve compared with other global central banks continued to command market direction.
The greenback has jumped more than 7% since the end of September, powered in part by growing expectations the U.S. economy will see accelerated growth under policies from President-elect Donald Trump, while sticky inflation has dampened expectations on how aggressive the Fed will be in reducing interest rates.
Those expectations for the U.S. stand in contrast to growth forecasts and the interest rate views for other global economies and central banks, which have led to expanding interest rate differentials.
The Fed last week projected a more measured path of rate cuts than the market had been anticipating, providing another boost to U.S. Treasury yields, with the benchmark 10-year note yield reaching a 7-month high of 4.629% on Tuesday.
“The markets are all having a little bit of a Christmas bonus with the election and they’re expecting positive things,” said Joseph Trevisani, senior analyst at FX Street in New York.
“Certainly that’s true for the dollar because we’ve seen a pullback in the expectations for further rate cuts, and as we all know, the most important factor for the currency markets is the rate structure between the central banks.”
The , which measures the greenback against a basket of currencies, rose 0.14% to 108.24, with the euro down 0.15% at $1.0389. The index is on track for its fifth gain in the past six sessions.
Trading volumes are likely to be thin through next week as the year draws to a close, with the economic calendar very light, and analysts expect rates to be the main driver for the foreign exchange market until the U.S. employment report on Jan. 10.
Sterling weakened 0.06% to $1.2527.
Against the yen, the dollar strengthened 0.1% to 157.34 as the Japanese currency remains near levels that have recently prompted Japanese authorities to intervene in an effort to support it.
Minutes from the Bank of Japan’s meeting last week showed policymakers agreed in October to keep raising interest rates if the economy moves in line with their forecast, but some stressed the need for caution on uncertainty over U.S. economic policy.
Trump’s return to the White House has brought about uncertainty over how his expected policies for tariffs, lower taxes and immigration curbs might affect policy.
Investing.com – The US dollar rose in thin holiday-impacted trade Tuesday, retaining recent strength as traders prepared for fewer Federal Reserve rate cuts in 2025.
At 04:25 ET (09:25 GMT), the Dollar Index, which tracks the greenback against a basket of six other currencies, traded 0.1% higher to 107.905, near the recently hit two-year high.
Dollar remains in demand
The dollar has been in demand since the Federal Reserve outlined a hawkish outlook for its interest rates after its last policy meeting of the year last week, projecting just two 25 bp rate cuts in 2025.
In fact, markets are now pricing in just about 35 basis points of easing for 2025, which has in turn sent US Treasury yields surging, boosting the dollar.
The two-year Treasury yield last stood at 4.34%, while the benchmark 10-year yield steadied near a seven-month high at 4.59%.
“We think this hawkish re-tuning of the Fed’s communication will lay the foundation for sustained dollar strengthening into the new year,” said analysts at ING,in a note.
Trading volumes are likely to thin out as the year-end approaches, with this trading week shortened by the festive period.
Euro near to two-year low
In Europe, fell 0.1% to 1.0396, near a two-year low, with the set to cut interest rates more rapidly than its US rival as the eurozone struggles to record any growth.
The ECB lowered its key rate earlier this month for the fourth time this year, and President Christine Lagarde said earlier this week that the eurozone was getting “very close” to reaching the central bank’s medium-term inflation goal.
“If the incoming data continue to confirm our baseline, the direction of travel is clear and we expect to lower interest rates further,” Lagarde said in a speech in Vilnius.
Inflation in the eurozone was 2.3% last month and the ECB expects it to settle at its 2% target next year.
traded largely flat at 1.2531, with sterling showing signs of weakness after data showed that Britain’s economy failed to grow in the third quarter, and with Bank of England policymakers voting 6-3 to keep interest rates on hold last week, a more dovish split than expected.
Bank of Japan stance in focus
In Asia, fell 0.1% to 157.03, after rising as high as 158 yen in recent sessions, after the signaled that it will take its time to consider more interest rate hikes.
edged 0.1% higher to 7.3021, remaining close to a one-year high as the prospect of more fiscal spending and looser monetary conditions in the coming year weighed on the currency.
Beijing signaled that it will ramp up fiscal spending in 2025 to support slowing economic growth.
Investing.com– Most Asian currencies moved in a tight range on Tuesday, while the dollar extended overnight gains as traders positioned for a slower pace of interest rate cuts in the coming year.
Trading volumes were muted before the Christmas break, while most regional currencies were nursing steep losses against the greenback for the year.
Asian currencies weakened sharply last week after the Federal Reserve effectively halved its outlook for rate cuts in 2025, citing concerns over sticky U.S. inflation.
Dollar near 2-year high on hawkish rate outlook
The and both rose about 0.1% in Asian trade, extending overnight gains and coming back in sight of a two-year high hit last week.
While the greenback did see some weakness after data read lower than expected for November, this was largely offset by traders dialing back expectations for interest rate cuts in 2025.
The Fed signaled only two rate cuts in the coming year, less than prior forecasts of four.
Higher U.S. rates diminish the appeal of risk-driven Asian markets, limiting the amount of capital flowing into the region and pressuring regional markets.
Asia FX pressured by sticky US rate outlook
Most Asian currencies weakened in recent sessions on the prospect of slower rate cuts in the U.S., while uncertainty over local monetary policy and slowing economic growth also weighed.
The Japanese yen’s pair fell 0.1% on Tuesday after rising as high as 158 yen in recent sessions, after the Bank of Japan signaled that it will take its time to consider more interest rate hikes.
The Australian dollar’s pair fell 0.2% after the minutes of the Reserve Bank’s December meeting showed policymakers saw an eventual easing in monetary policy, citing some progress in bringing down inflation. But they still flagged potential upside risks for inflation.
The Chinese yuan’s pair rose 0.1% and remained close to a one-year high, as the prospect of more fiscal spending and looser monetary conditions in the coming year weighed on the currency.
Beijing signaled that it will ramp up fiscal spending in 2025 to support slowing economic growth.
The Singapore dollar’s pair rose 0.1%, while the Indian rupee’s pair rose 0.1% after hitting record highs above 85 rupees.
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