FX markets have been surprisingly calm over the past few years, and it looks like only a crisis might wake the sleeping bear.
This week, the JP Morgan global foreign exchange volatility index fell to its lowest level since September 2014. With the slowing of growth in the world’s largest economies, in addition to the uncertain future of central banks’ evolving monetary policy, the $5.1 trillion-a-day FX market has been subdued.
In 2014, volatility was sapped from currency markets as reserve banks from Japan to the U.S. found themselves preserving a stimulus to prop up the economy in the wake of the financial disaster. That didn’t change up until the Federal Reserve began to signal that it would be the first to raise rates, doing so in December 2015.
It is that weak development outlook that is allowing the stock exchanges to rally while keeping a cap on big swings in forex markets, stopping central banks from “normalizing” monetary policy and withdrawing liquidity from markets.
The United States Federal Reserve is showing that it will not increase rates in the short term, while the European Central Bank is once again thinking about a stimulus. The Bank of England, meanwhile, has surprised investors, becoming a potential candidate for a tighter monetary policy amidst growing fears over Brexit.
The move to leave the European Union is just over a month away, while economic concerns over Italy and Spain persist. Looming European parliamentary elections at the end of May are another possible source of political headwinds.
Despite these mounting worries, however, the euro has been selling in a tight range, between $1.12 and $1.18 versus the dollar for more than 70 trading days.
Crisis might trigger increased volatility in FX markets.
Still, the serenity might not last permanently, according to MUFG Bank and Russell Investments. They mention such possibilities as a hawkish turn by the Federal Reserve, a Chinese economic downturn and a U.S. recession as events that might awaken currency markets from their nap.
Derek Halpenny, European head of global markets research at MUFG explained, “It looks increasingly likely that some form of fresh crisis could be required,” adding, “Markets are pricing a long period of monetary policy stability.”
For Russell Investments, investment strategies that follow foreign-exchange patterns will likewise gain from a “proper crisis” due to the fact that commodity and cyclical currencies, such as the Australian dollar, would sell-off having traded in very narrow varieties recently.