Central bank synchronization puts foreign exchange market to sleep

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Currency updates

Central banks’ efforts to stabilize the global economy since the start of the pandemic have rocked the currency market $ 6.6 billion a day in one of its most sleepy spells on record.

As the economic recovery began to set in this spring and summer, stock markets around the world rushed higher and government bond prices swung in anticipation of the direction of monetary policy. During this time, prices in the forex market moved very little and the trading volume fell to its lowest level in several months. The exchange rate between the US dollar and the euro has traded this year in the narrowest range on record.

This is because central banks around the world have moved more or less at the same pace since the start of the pandemic, creating very little chance that currencies will diverge in ways that create opportunities for profit. Even Monday’s turmoil in markets sparked by Chinese developer Evergrande’s crisis barely rattled currencies from its slumber, with major currencies remaining in their recent ranges.

“The forex market is exciting when central banks move in different directions, when policies diverge. Right now, all central banks keep key rates close to zero at least in developed markets, ”said Sam Lynton-Brown, head of developed markets strategy at BNP Paribas.

The divergence between currencies has also narrowed because the central bank policy of the Covid era has become such a dominant price driver, ruling out other factors that typically move in the market. Interest rates are still paramount for currencies, but the global response to the pandemic has meant that domestic events, like the German election, do not have the same ability to move markets as they once did, Shahab said. Jalinoos, Global Head of Foreign Exchange Strategy. to Credit Suisse.

Trading volume in the currency futures and options market fell dramatically in August to its lowest level since April 2020, according to data from the CME. And it’s not just a summer slowdown: it is the slowest August since 2009. More generally, the average daily trading volume for the year is also the lowest since 2009.

Column chart of the average daily trading volume in the futures and options market, in thousands showing that Forex trading volumes have fallen this year

In developed country currencies, recent enthusiasm has largely been confined to Australia and New Zealand, two economies whose central banks are much closer to raising interest rates than their peers.

Investors are positioned for more of the same. Measures of expected volatility in forex markets have steadily declined since they exploded higher at the start of the pandemic. The euro’s three-month implied volatility against the dollar – a widely tracked indicator of the expected volatility of the world’s most traded currency pair based on option prices – has fallen to its lowest level in the world. year in mid-September, and closes at its all-time low since early 2020. Similar measures for the pound sterling and the yen against the dollar are also near their all-time lows.

The lull was bad news for investors looking to profit from lasting trends or periods of exchange rate volatility. Macro hedge funds, which bet on movements in bonds, currencies and commodities, have struggled this year, even during an industry-wide rebirth. Macro currency trading funds fell 1.4% this year through the end of August, according to the HFR data group, while hedge funds as a whole register 10% gains so far this year. .

Once central banks signal that they are ready to change their interest rate policy, this forex lull could evaporate. “Given the number of issues the markets will face in the coming year – high inflation, hike in central bank rates, hike in taxes, geopolitical tensions – we doubt that currency volatility will stay depressed for very long. “said Zach Pandl, co-director. foreign exchange strategy at Goldman Sachs.

Nonetheless, future changes in interest rate policy, when they occur, may be less significant than in the past given the scale of debt incurred during the pandemic, said Ulrich Leuchtmann, head of the pandemic. forex research at Commerzbank.

“We’re very concerned about whether the Fed will begin its take-off in late 2022 or early or mid 2023 after all. And we don’t agree on whether the ECB will follow suit in 2024 or 2025. . . But to be fair, that uncertainty is pretty low compared to what was at stake before. This is still a long way off, ”said Leuchtmann.

Additional reporting by Laurence Fletcher and Eva Szalay in London


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