Markets may be mostly sleepy ahead of the Kansas City Fed’s economic symposium at Jackson Hole later today, but there are tentative signs that traders are preparing for a pick-up in volatility as the summer lull comes to an end over the next few weeks.
Central bank-watchers are not expecting fireworks from Fed chair Janet Yellen or ECB president Mario Draghi, who are both due to speak later today, but will still be watching closely for any hints on the timing of policy shifts.
Analysts at ING noted this morning that Mr Draghi “will do his utmost to avoid sending the euro higher”, but added that “the fact is that the ECB will be normalising policy because the economy is doing well”, which will put upward pressure on the currency over the longer-term.
Moreover, as the Dutch bank points out, Mr Draghi’s speech will take place after European markets close, meaning “his remarks will impact the euro in thin trading conditions”, raising the chance of sharper moves.
The chance of a surprise from Jackson Hole, as well as wider market repositioning as traders return to their desks in September, has pushed one measure of euro/dollar volatility expectations to its highest level since the French presidential election.
Euro-dollar two week implied volatility rose to 8.4 per cent on Friday, its highest level since the days before Emmanuel Macron’s second-round victory.
Implied volatility measures demand for options to hedge against big currency swings, with a higher percentage reflecting greater expectations of currency movements over a given period.
Derek Halpenny, European head of global markets research at MUFG, said market volatility often increases in September, but he said currencies are likely to be particularly unpredictable this year given uncertainty over the timing of ECB policy and potential policy deadlock in the US:
In eight of the last ten years, the dollar index on a month-to-month closing basis moved by at least 1.6 per cent and by as much as 6 per cent in September.
This may reflect market participants returning after the summer break repositioning for the final view of the calendar year [but] there are fundamental factors that suggest the potential for a big DXY move this year too.
The two years in which the DXY moves were not large were the two most recent years when ECB monetary policy helped dampen volatility. With the ECB monetary policy outlook now in flux, that source of stability is gone. The other obvious source of potential volatility comes from uncertainty in Washington with both the debt-ceiling and the budget for the new fiscal year holding the potential for increased market volatility. History does not favour a direction for the dollar but we would see far greater downside risks in September based on the fundamental backdrop mentioned here.