Currencies

Currency markets are in a deep freeze. Rate cuts and Trump could thaw them -April 04, 2024 at 01:00 am EDT

LONDON, April 4 (Reuters) – Traders and investors are
looking to global interest rate cuts and a closely-fought U.S.
election to drag the world’s currency markets from their deepest
lull in almost four years.

Measures of historical and expected volatility – how much
prices move over a set time period – have sunk in recent months
with the world’s biggest central banks stuck in a holding
pattern, depriving FX traders of the divergent moves between
regional bond yields on which they thrive.

Deutsche Bank’s closely-followed implied currency volatility
gauge is around its lowest in two years, and not far off
pre-pandemic levels.

“The music isn’t playing in FX so far this year,” said
Andreas Koenig, head of global FX at Amundi, Europe’s biggest
asset manager. “U.S. (bond market) rates go up and down, but the
others all follow, and therefore we have no change in
differentials.”

“Who’s cutting first and how far…and then the U.S.
elections, will be the FX events, the big macro events,” Koenig
said.

Central banks are slowly stirring. The Swiss National Bank
in March was the first major central bank to lower borrowing
costs this cycle. The Federal Reserve, European Central Bank,
and Bank of England are expected to follow later this year.

Although U.S. yields have risen in recent days as investors
reined in bets on Fed rate cuts after stronger-than-expected
data, euro zone bond yields have largely followed suit.

“What would lead to any real volatility is increased
differentiation among central banks,” said Samuel Zief, head of
global FX strategy at JPMorgan Private Bank, although he said
that’s unlikely in the first half of the year, with European and
U.S. inflation following a broadly similar path.

TRUMP CARD

Donald Trump also looms large, last year floating the idea
of a 10% universal import tariff should the former U.S.
President regain the White House and in February adding that he
could slap levies of 60% or more on Chinese goods.

“Tariffs, extra tax, means the dollar could get stronger,”
said Themos Fiotakis, global head of FX strategy at Barclays,
adding that the euro and the Chinese yuan would likely suffer.

Barclays thinks the dollar could rally 3% on the back of
tariffs in the event Trump secures a second term and has even
said the euro could drop to parity with the U.S. currency.

Trump and Joe Biden currently appear neck and neck,
suggesting heightened volatility in the $7.5-trillion-a-day
global currency market as opinion polls swing in the run up to
November’s election.

Oliver Brennan, FX volatility strategist at BNP Paribas,
said options, which let investors bet on currency prices,
suggest traders are bracing for moves in the Mexican peso
, Polish zloty and the yuan, all of which
tumbled after Trump’s 2016 victory.

“Volatility in the 9-month to one-year range (for those
three currencies) is really high, and because nothing is
happening now, volatility is really low,” he said.

“If you look at any currency there is a kink around the
November election, but the kink is huge in those three.”

NOT WORTH TRADING

For now, the volatility slump is limiting opportunities.

“Looking at our risk today, substantially less than the
long-term average is allocated to currency,” said Jamie Niven,
senior portfolio manager at Candriam.

That’s particularly true in certain currency pairs. “It’s
not worth trading euro-sterling at the moment,” said Yusuke
Miyairi, strategist at Nomura. Volatility in the pair is at its
lowest since 2006.

There are, however, signs rate moves are beginning to drive
pockets of volatility.

The Bank of Japan raised rates for the first time in 17
years in March, but that didn’t stop the yen tumbling to near
its lowest since 1990 as traders realised Japanese borrowing
costs would stay near zero.

Strategists said that led to swings in Asian currencies
including China’s yuan, showing how fluctuations in one area can
ripple across the market.

Direct intervention by Japanese authorities to prop up their
currency could provide another jolt.

In Europe, Switzerland’s rate cut helped the euro post its
biggest quarterly gain on the franc since the common currency’s
creation.

Meanwhile, investors are doing what they can.

“If volatility is low, we find carry trade strategies
particularly attractive,” said Guillaume Rigeade, co-head of
fixed income at Carmignac, referring to trades where investors
borrow in a currency with low rates to buy higher-yielding ones.

He said low volatility also makes it cheaper to hedge an
equity or bond portfolio.

For JPMorgan’s Zief, there have been worse times. “At least
we have an environment where yes, it’s low volatility, but there
are carry trades,” he said. “Low volatility with very low
rates…is even worse.”

(Reporting by Harry Robertson and Alun John; Editing by Amanda
Cooper and Kirsten Donovan)

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