FX Trading focus: Volatility picking up, but still quite sluggish. Sterling stumbling.
Implied volatilities among currency pairs are a slightly mixed bag here over the last couple of weeks of heightened volatility in risky assets – EURUSD 1-month volatility actually bottomed last Friday below 4.6% and ahead of the weekend election, which gives a sense of how little the market was anticipating that particular event. With EURUSD poking at the bottom of the range, it has picked back up above 4.9%, but that is a historically very low level. Elsewhere, volatility has picked up more, with USDJPY 1-month hitting its high level since July just below 6% before easing back lower (that volatility measure was as low as sub-5% less than a week ago). Sterling volatility has picked up more sharply. As I mention in the EURUSD chart below, the setup that could really jolt volatility might be a further risk deleveraging in which bond yields actually stay sidelined or even fall rather than rise, which might turn the tables again on JPY traders. Until then, the FX market feels quite sluggish outside of the sterling and JPY moves of late.
Yesterday, sterling hit a brick wall and fell sharply versus both the US dollar and the euro, taking out key support for the currency. I suspect the chief driver is sterling’s general sensitive to risk sentiment, its vulnerability in terms of the ongoing energy crunch and prices of commodity imports, and a UK economy beset with capacity constraints, while the furlough scheme is set to lift, which could mean a slowing of the recovery. In the pipeline, we have a government that looks determined to ensure that it shores up the budget imbalance, i.e., austerity incoming. GBPUSD fell through the key 1.3600 area and is already having a look at the huge 1.3500 level that was important in both 2019 and 2020. EURGBP, for its part, reversed the modest kneejerk reaction to the downside in the wake of the German election and ripped above the range of the last several weeks and well clear of the 0.8600 level. The pair is trading near the 200-day moving average (from below) for the first time since early January.
Chart: EURUSD – what’s with the slow-mo act?
I suspect there are a couple of drivers of muted EURUSD volatility over the last few sessions, relative to what we have seen elsewhere. First, the market quickly unwound the slightly negative reaction to the euro in the wake of the German election, at least in EURGBP, where the Monday sell-off was swamped with a massive rise yesterday that cleared several weeks of range-trading. Second, the focus on rising yields has meant more focus on selling JPY rather than the euro, where yields are seen as capable of responding in sympathy, if with lower beta, to the rise in US treasury yields, while the Japanese policy of yield control keeps the JPY the weakest whenever yields rise. So that begs the question of what could cause a EURUSD sell-off to extend notably below the 1.1664 support. It appears that this would require a chunky further risk deleveraging without the proximate cause being a . That would allow both EURUSD and EURJPY to come under pressure and set up the run at the structural support in EURUSD, which starts with the 1.1500 area and extends to the arguably existential level of support at 1.1290, the 61.8% retracement of the entire rally from post-pandemic outbreak lows to the highs in January. A strong turn in the mood/reversal needed to neutralize the downside threat.