Volatility traders are betting that the spins in the forex markets will likely last until next year, even if the omicron Covid variant fears subside.
The currency volatility seen in the Bloomberg Dollar Spot Index is nearing a six-month high, as uncertainty about the virulence of the latest mutation causes huge swings during what is typically a quiet last month of the year. Meanwhile, several currency pairs have posted their biggest daily swings in months, including a 1.7% drop between the dollar and the yen, a 2.1% rise for the euro against the Canadian dollar, 1.8 swings % of the euro against the Swedish krona and 1.3%. fall of the Australian dollar.
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While the fluctuations may have been exacerbated by profit-taking before the end of the year, and markets have calmed down this week ahead of a series of central bank meetings, concerns about how these monetary authorities will balance inflation risks with The potential threat of increased virus cases are obvious. . A gauge of implied volatility on the Bloomberg dollar gauge is near a nine-month high ahead of Wednesday’s Federal Reserve policy announcement. Meanwhile, the cost of hedging the pound and the euro is around year-to-date highs.
That’s because these concerns have been building up over time. Before omicron emerged, currency traders were positioning themselves for a difficult start to the new year courtesy of the Fed, buying longer-term options in currencies sensitive to Treasury market movements and higher interest rates.
The volatility of the one-year yen bottomed out in the second week of September, and hedging costs gradually increased along with expectations of a rate hike from the Fed. And, in October, the three-month volatility in the Japanese currency, Often seen as a haven, it moved above JPMorgan Chase & Co.’s broader G-7 volatility index for the first time in more than a year, a sign that market complacency was waning.
Meanwhile, the demand for longer-term options has caused the US dollar implicit curve to steep, in contrast to the past three years, when its steepening was mainly due to the drop in volatility at the short end in the middle of a depressed general action. These buyers should stay because of attractive option prices; the level of volatility from which prices are derived is below the median of the last five years and 3% below those observed in 2016.
An additional layer of demand was added in late November when the omicron spread triggered a significant increase in appetite for yen call options. That jolt also turned the correlation between the ICE dollar index and the S&P 500 index positive for the first time since April 2020, a sign that a stronger dollar will depend on a resilient US equity market. Additional demand for safe haven currency calls would suggest that volatility is turning contagious.
To be sure, US financial conditions remain accommodative and inflation may recede as bottlenecks ease. But currency traders are preparing for fireworks heading into 2022.
© 2021 Bloomberg