Bloomberg News

Traders Bemoaning Losses Detect Volatility Reprieve

July 28, 2014

Currency traders are detecting the first signs of what they’ve been waiting for all year: a revival in volatility that may help trim their losses.

Tensions in Ukraine and Gaza, together with interest-rate increases from New Zealand to South Africa (SARPRT), are helping push up a measure of price swings by the most since January. Volatility had flattened in recent months as policy makers continued to provide unprecedented amounts of cheap cash to spur growth.

While rising volatility increases uncertainty and risk, it also creates opportunities for traders to profit on changes in exchange rates. Parker Global Strategies LLC’s index of currency returns rose 0.5 percent last week in its biggest gain since March.

“We’ve seen some tentative signs that volatility is picking up,” Ian Stannard, the head of European foreign-exchange strategy at Morgan Stanley in London, said in a July 25 phone interview. “Given this is the first movement we’ve seen for quite some time, I’m putting quite a bit of emphasis onto that. A few bits and pieces are starting to fall into place to support this change in market behavior.”

JPMorgan Chase & Co.’s Global FX Volatility Index rose for the past three weeks, climbing from a record low in the most sustained run of increases in six months.

Crisis Peak

The gauge reached 5.60 percent today, up from an all-time low on a closing basis of 5.29 percent on July 3. The index had tumbled from a high for the year of 8.98 on Feb. 3 and a peak of 27 percent during the worst of the global financial crisis in October 2008.

Price swings have widened for nine of 31 major currencies tracked by Bloomberg in July, led by Israel’s shekel and with Russia’s ruble in the top five, based on one-month options.

As well as geo-political tensions, volatility is also increasing as central banks around the world start raising borrowing costs after years of rate convergence. In March, New Zealand became the first developed country to lift rates since 2011, and traders are speculating the U.K.’s Bank of England is preparing to tighten policy next year.

Russia unexpectedly raised the one-week auction rate on July 25 and South Africa lifted its benchmark more than economists forecast earlier in the month.

Policy Divergence

“The main driver that we think can push volatility higher is for monetary policy divergence to pick up,” Anezka Christovova, a foreign-exchange strategist at Credit Suisse Group AG in London, said by phone on July 24. “But we need stronger divergence in data and actual policy steps to really confirm that pickup.”

A policy split between the Federal Reserve and European Central Bank helped the euro tumble to an eight-month low of $1.3422 on July 25 and is pushing it outside of its five-cent trading range in the first half of the year. Implied three-month volatility in euro-dollar, the world’s most-traded currency pair, rose to as high as 5.47 percent on July 23, from a record-low 4.75 about a week earlier.

While Fed Chair Janet Yellen told lawmakers this month that the U.S. still needs an accommodative monetary policy, she also said borrowing costs may rise sooner than investors expected. The ECB, by contrast, took one of its key rates negative in June.

‘Global Shocks’

Apart from “global shocks,” what will push volatility significantly higher is “when the Fed starts sounding more confident about the economy, and as a result, having a more hawkish tone,” Athanasios Vamvakidis, the head of Group of 10 currency strategy at Bank of America Corp. in London, said by phone on July 23. “We might not be far from this.”

Societe Generale SA’s Olivier Korber is less confident volatility has really turned a corner. Price swings remain close to the narrowest ever and that’s not going to change any time soon, said Korber, a derivatives strategist in Paris.

“I don’t see exactly how and why volatility could really pick up,” Korber said by e-mail on July 22. “There’s no game-changer in sight.”

The July 17 downing of Malaysian Airlines flight MH17 over rebel-held territory in Ukraine has resulted in international sanctions against Russia. The plane was hit by a missile which the U.S. says was probably fired from a launcher supplied by Russia, which denies involvement.

Israel, Gaza

Late last week, the U.S. accused Russia of shelling Ukrainian military positions across its border, further heightening tensions. Also stoking volatility is the conflict between Israel and Gaza, which has killed more than 800 Palestinians and 35 Israeli soldiers.

The foreign-exchange strategy that has made the most money this year is the so-called carry trade, which exploits differences in global interest rates and where low volatility makes profits more reliable.

The Parker Index, which tracks the returns of 14 top currency funds, has rebounded 0.6 percent since the Ukraine missile strike. It’s still down 3 percent this year, though, on pace for its worst annual performance since 2011.

“We may be beginning to emerge from this phase where nothing happens,” Steven Englander, the head of G-10 currency strategy at Citigroup Inc. in New York, said in a July 18 Bloomberg Radio interview. “There’s a sense that the very placid period may be coming to an end. It’s not coming to an abrupt end, but it does seem that the basis of this low volatility is eroding.”

To contact the reporter on this story: Neal Armstrong in London at narmstrong8@bloomberg.net

To contact the editors responsible for this story: Paul Dobson at pdobson2@bloomberg.net Paul Armstrong, Kenneth Pringle


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