Even the Foreign-Exchange Market Is Getting Kind of Crazy

Currency volatility is back.

The JPMorgan Chase & Co index. Measures the volatility of currencies relative to the Group of Seven has grown by more than 70% this year. A measure of the euro’s volatility has more than doubled since November, mostly in March. The forex volatility gauge spiked as the currency rapidly depreciated.

The price swings are another sign of how lingering inflation and global supply chain shocks have ravaged financial markets in 2022. Rising interest rates, Russia’s invasion of Ukraine and recession The economic downturn in China has upset the normally calm forex universe. The dollar has risen rapidly and the WSJ Dollar Index, which measures the dollar against a basket of currencies, has gained more than 13% over the past year. The euro has fallen more than 14% against the dollar and the pound has depreciated by almost 13% over the same period.

Betting on currencies used to be a hot deal among hedge funds. But the money markets calmed down after the 2008 financial crisis, robbing traders of the volatility they needed to make big profits.

Jeff Yarmouth, head of forex options in the Americas at UBS, said the large daily dollar volatility and rapid decline in equities are leading to a sharp increase in currency volatility.

The bond market, which is often a haven when stocks plunge, has also been volatile. Yields on the benchmark 10-year Treasury note have risen above 3% in May and are up 1,381 percentage points so far. The Federal Reserve has raised interest rates twice this year to try to contain inflation, driving up borrowing costs for everything from car loans to home mortgages.

“Look how fast mortgage rates have moved. At some point, forex volatility needs to catch up,” said Mazen Issa, forex strategist at TD Securities.

Investors often focus on economic growth before buying or selling assets. Some of their bets now are essentially bets on the central banks of the countries that will step in the hardest to tighten borrowing conditions. Investors are flocking to the dollar partly because they believe other countries’ central banks are not moving fast enough to quell inflation.

The dollar functions as the world’s reserve currency, playing a dominant role in the global economy. A strong dollar allows Americans to buy goods from other countries at lower prices, but it can also hurt American businesses by making their services or products more expensive for them. with foreigners. It can also indirectly export inflation to emerging market economies by devaluing the strength of their local currencies.

Open interest in forex options rose 73.9% at the end of April, year-over-year, according to CME Group Inc. Chicago-based company that analyzes a wide range of things from stocks to corn futures. Open interest, a closely watched indicator of volume growth, represents the number of contracts bought or sold but left open overnight with no clearing.

Chris Grams, a spokesman for the exchange operator, said inflation pressures and geopolitical tensions continue to contribute to increased trading activity in futures and currency options. Average daily options volume in Japanese yen alone increased by nearly 200% in April compared to the first month of the year.

Some hedge funds sold the pound as the Bank of England said it likely won’t raise interest rates in the coming months – in contrast to Fed officials, who broadly agreed there would be more Half a point increase in June and July. Zach Pandl, co-head of foreign exchange strategy at Goldman Sachs said the BOE’s policy is very different from peers and is likely to drive the pound lower. more.

“Other central banks are now reacting more aggressively to the changing inflation outlook,” said Mr Pandl.

Meanwhile, some of the world’s biggest asset managers are betting against the euro as they expect it to fall even further. They cite lackluster growth, rising consumer prices and a potential energy crisis in the EU, which has proposed banning oil imports from Russia. It now costs almost twice as much to buy a put option — allowing the holder to sell at an agreed price — per currency than it did six months ago.

“I’m not sure how you would expect Europe to catch up to the US as they experience these shocks every few years,” said Thanos Bardas, co-head of investment-grade credit at asset manager Neuberger Berman. time. commenced in 2010. Mr. Bardas has holdings that will benefit from a stronger dollar against the euro and Japanese yen.

The ongoing conflict between Russia and Ukraine causes banks to charge more for derivatives tied to the euro. That’s because banks price derivatives directly from so-called implied volatility, a calculation of how volatile a currency will be over a month or other time period.

Investors are also looking for options tied to the Japanese yen. The yen usually strengthens when the stock market falls as Japanese investors sell dollars to liquidate US assets.

Write letter for Julia-Ambra Verlaine at Julia.Verlaine@wsj.com

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https://www.wsj.com/articles/even-the-foreign-exchange-market-is-getting-kind-of-crazy-11652788980?mod=rss_markets_main Even the Foreign-Exchange Market Is Getting Kind of Crazy

Edmund DeMarche

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