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US dollar weakness fuels surge in currency volatility
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The dollar's descent is elevating the price of hedging currency trades around the world, breaking up a long-standing market conviction that costs tend to come down when the greenback weakens.
The correlation between the dollar and a widely-watched gauge of volatility in Group-of-10 currencies fell to the lowest level in seven years this week. For most of the past 15 years that correlation was positive.
The structural shift shows traders are preparing for wilder swings in markets as opposed to the usual stability that comes with a softer dollar.
Options trading has surged this year, with daily average volumes since January exceeding the 12-month average, according to data from the Depository Trust & Clearing Corporation.
"This is just the beginning so buckle up," Andrew Ng, head of global financial markets at DBS Bankm said at the International Swaps and Derivatives Association conference in Amsterdam. "Long volatility is probably the key trade."
This week's moves in spot and options markets suggest traders are right to prepare for ample swings.
On Monday, the dollar rallied on the US-China trade deal and one-month implied hedging costs fell to their lowest levels since late March.
But in the following days the currency weakened on the back of softer US inflation data and speculation that President Donald Trump favors a weaker greenback, fueling demand for long-volatility exposure, especially in longer tenors.
"Realized FX volatility is high, and I think it is likely to stay high for some time," Goldman analyst Kamakshya Trivedi said on Bloomberg TV.
The moves suggest the FX market is positioning for a prolonged dollar downtrend. Also interbank traders say there's heightened demand for hedges further out the curve as clients position for a regime change.
The correlation between the dollar and a widely-watched gauge of volatility in Group-of-10 currencies fell to the lowest level in seven years this week. For most of the past 15 years that correlation was positive.
The structural shift shows traders are preparing for wilder swings in markets as opposed to the usual stability that comes with a softer dollar.
Options trading has surged this year, with daily average volumes since January exceeding the 12-month average, according to data from the Depository Trust & Clearing Corporation.
"This is just the beginning so buckle up," Andrew Ng, head of global financial markets at DBS Bankm said at the International Swaps and Derivatives Association conference in Amsterdam. "Long volatility is probably the key trade."
On Monday, the dollar rallied on the US-China trade deal and one-month implied hedging costs fell to their lowest levels since late March.
But in the following days the currency weakened on the back of softer US inflation data and speculation that President Donald Trump favors a weaker greenback, fueling demand for long-volatility exposure, especially in longer tenors.
"Realized FX volatility is high, and I think it is likely to stay high for some time," Goldman analyst Kamakshya Trivedi said on Bloomberg TV.
The moves suggest the FX market is positioning for a prolonged dollar downtrend. Also interbank traders say there's heightened demand for hedges further out the curve as clients position for a regime change.
Source - Bloomberg
