Volatility is back in FX markets. J P Morgan's (NYSE:JPM) proprietary global index of volatility has risen to the highest level in eight months in the past 24 hours having fallen by 45% through the first six months of this year. That was until GBP singlehandedly brought it higher through September as the market chewed through the effects, ramifications and general bluster of the Scottish Independence Referendum. I would surely not be bemoaning the lack of currency volatility had Salmond and the ‘Yes’ campaign won.
Even with the prospect of a break-up of 308 years of currency union, volatility levels only really returned to within half a standard deviation of the past ten year average and that was at the very short end of the curve. If the collapse of a country – not a bad payrolls report, central banker language SNAFU or below par inflation report – can only see a real shift in the short end of volatility curves, then something was thought to be very wrong with our landscape.
Now, however, we are back into a market where haven currencies are being fired higher at the expense of riskier assets. Japanese yen has enjoyed its biggest fortnightly gain since June of last year, Swiss franc is rolling stronger and the pound and the euro are excelling as well. The one thing missing from this equation is the US dollar, which had its knees taken from under it by a central banker’s comment yesterday afternoon.
As soon as we started to see these latest ructions, we believed that it was only a matter of time until a research note or comment on additional monetary stimulus was published. As we said on Wednesday, with the Fed stepping off the bond buying stage by closing off its QE plan at the end of this month, we have to wonder just how rates would go before intervention from the central bank. Yesterday, Federal Reserve member Bullard told Bloomberg that the Federal Reserve ‘should consider a delay in ending quantitative easing’.
There are a lot of things that are surprising about that statement. Possibly the most surprising is that it has taken only two days of volatility to take a member, albeit not a voter this year or next, of the most powerful central bank in the world to feel the need to raise the prospect of a reversal of 11 months of policy. We have to remember that the tapering of asset purchases from the original level of $85bn a month is nearly complete; the Fed is currently only spending $15bn a month on treasuries and mortgage backed securities at the moment.
How much difference that would make is very marginal in my estimates. What it has done is further kick interest rate expectations along the curve. Traders now estimate a Fed interest-rate increase in December 2015 at a 61% probability, suggesting it’s now the earliest date for a likely move. They saw a 52% chance for the Fed to tighten in July next year as recently as October 3rd.
Bank of England members are also joining the party, although by simply emphasising that the Bank could keep rates at current levels without an associated risk of increased inflation. Volatility in sterling crosses remains high at the moment even with the Scottish referendum in the books as we continue to weigh up 2015’s political risk, and could damage prospects for the pound as a port in the current market storm for investors.
The biggest mover overnight has been the NZD following another central bank snafu. The Reserve Bank republished its statement from September 25 saying that the level of the NZD was unjustifiably high. NZD recovered its losses once the statement had been retracted.
Today’s markets are once again rather data-free but that is no guarantee of tranquility as we feel that this ongoing market situation definitely has the legs to continue.
