Thu, 28th Nov 2019 16:06
By Olga Cotaga
LONDON, Nov 28 (Reuters) – As 2019 heads into its final
month, currency markets show no sign of waking from their
slumber, with key gauges of expected swings in the euro-dollar
rate plumbing new record lows this week.
Implied volatility gauges embedded in currency options
markets have been bumping along at multi-year lows as central
bank stimulus policies since 2009 flooded financial markets with
liquidity. The listless markets have dismayed traders who make
money when there are big exchange rate swings, as that raises
demand from clients to hedge currency exposure.
But hopes of a pick-up in volatility have been dashed as
U.S. interest rate cuts this year were followed by monetary
policy easing from other central banks worldwide. The Federal
Reserve has even resumed its balance sheet expansion.
Trading ranges in the euro/dollar pair this week were the
narrowest in 20 years, falling to around 20 pips on Monday,
analysts at Nordea pointed out.
And implied euro/dollar volatility, calculated using option
prices on a three-month horizon, is trading at 4.27%, the lowest
on record, having fallen from 7.16% in January.
One-year volatility — or vol in traders’ parlance, is also
at a record low of 5.48%, down two percentage points this year
.
Market participants reported relentless demand to sell
options which are often used to hedge against unexpected
currency moves. Option sellers can then collect premiums — a
steady income stream — from the buyers.
“Basically people are chasing yield and one of the ways you
could generate a yield (is) if you could write options,” said
John Stopford, fund manager at Investec Asset Management.
Uncertainty about the political and economic outlook remains
high, said Stopford, citing trade wars, Brexit and protests in
Hong Kong and across emerging markets. But “the pricing of
insuring against those kind of events has actually just got
stuck,” he added.
The renewed euro-dollar vol slump has taken a forex
volatility index near record lows hit in April at 5.48%
Low vol begets more of the same. That’s because option
buyers by default are ‘long’ volatility but they tend to hedge
that position by trading the underlying currencies in spot
markets, selling when the currency goes up and buying as it
falls.
That in turn lowers actual volatility and further reduces
the incentive to buy hedges, a circle which Stephen Gallo,
currency strategist at BMO Capital Markets, described as a
“self-feeding doom loop”.
(Reporting by Olga Cotaga; editing by Sujata Rao, William
Maclean)