Even the forex market is going a little crazy

Currency volatility is back.

A JPMorgan Chase & Co. index measuring currency movements related to Group of Seven countries has jumped as much as 80% this year. A measure of euro volatility has more than doubled since November, rising mostly in March. Currency volatility gauges jump when a currency rapidly loses value.

Price swings are another sign of how protracted inflation and global supply chain shocks have wreaked havoc on financial markets in 2022. Rising interest rates, The Russian invasion of Ukraine and an economic slowdown in China disrupted the normally calm FX landscape. The dollar has surged rapidly and the WSJ Dollar Index, which measures the dollar against a basket of currencies, has gained more than 12.5% ​​over the past year. The euro has lost almost 14% against the dollar and the pound has lost around 12% over the same period.

Currency betting was once a hot business among hedge funds. But forex markets went quiet after the 2008 financial crisis, depriving traders of the volatility they need to make big profits.

Jeff Yarmouth, head of FX options for the Americas at UBS, said sharp daily swings in the dollar and rapid stock declines were behind the sharp rise in currency volatility.

Bond markets, which are usually a safe haven when stocks plunge, were also tumultuous. The yield on the benchmark 10-year Treasury note rose above 3% in May and is up 1.473 percentage points since the start of the year. The Federal Reserve has raised interest rates twice this year in an attempt to rein in inflation, pushing up borrowing costs for everything from auto loans to home loans.

“Look how quickly mortgage rates have moved. At some point, the currency volatility had to catch up,” said Mazen Issa, currency strategist at TD Securities.

Investors have generally focused on economic growth before buying or selling assets. Some of their bets are now basically betting on which central banks of countries will intervene most aggressively to tighten borrowing conditions. Investors turn to the dollar in part because they think other countries’ central banks are not moving fast enough to curb inflation.

The dollar acts as the world’s reserve currency and plays a key 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 foreigners. It can also indirectly export inflation to emerging economies by devaluing the strength of their local currencies.

Open interest in forex options was up 73.9% at the end of April, compared to the same period a year earlier, according to Chicago-based CME Group Inc., which offsets a range of things from 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 trade clearing.

Chris Grams, a spokesman for the stock trader, said inflationary pressures and ongoing geopolitical tensions contributed to increased trading activity in currency futures and options. The average daily volume of options contracts on the Japanese yen alone increased by almost 200% in April compared to the previous month.

Some hedge funds sold sterling because the Bank of England signaled it may not raise interest rates in the coming months, unlike Fed officials who largely agreed that further increases in half points are on the table in June and July. Goldman Sachs co-head of FX strategy Zach Pandl said the BOE’s policy differs widely from that of its peers and will likely cause the pound to fall further.

“Other central banks are now reacting more forcefully to changing inflation prospects,” Pandl said.

Meanwhile, some of the world’s biggest asset managers are betting against the euro because they expect it to continue falling. They cite lackluster growth, rising consumer prices and a potential energy crisis in the EU, which has proposed to ban oil imports from Russia. It now costs almost twice as much to buy put options – which allow the owner to sell at an agreed price – on the currency compared to six months ago.

“I don’t know how you expect Europe to catch up with the US when they go through all these shocks every few years,” said Thanos Bardas, co-head of investment-grade credit at the manager. of Neuberger Berman assets, referring to the bloc’s sovereign debt crisis. which began in 2010. Mr. Bardas holds holdings which will benefit from the rise of the dollar against the euro and the Japanese yen.

The ongoing conflict between Russia and Ukraine is pushing banks to charge more for euro-linked derivatives. This is because banks price currency derivatives directly on so-called implied volatility, a calculation of how a currency moves over a month or other periods.

Investors are also picking up options tied to the Japanese yen. The yen typically strengthens when stock markets fall, with Japanese investors selling dollars to liquidate US assets.

Write to Julia-Ambra Verlaine at [email protected]

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