BNY Mellon: The Odd Currency Out On Volatility

6 feb 2019

By Simon Derrick, Chief Currency Strategist, BNY Mellon

• Realized volatility in a wide range of currency pairs has moved to levels well below long-term averages
• GBP crosses currently an exception to this pattern
• Realized volatility in a range of GBP crosses has been rising since last summer's Parliamentary recess

While the broad impact of easier central bank rhetoric has been to bring downward pressure to bear upon realized volatility, it’s worth noting that the outcome has been somewhat different across asset classes.

While realized volatility in the S&P 500 and Brent crude has simply reverted back to the average levels seen over the past decade, the same cannot be said in the currency markets where the declines that have emerged since the start of the year have been deep and widespread.

Looking at CAD crosses as just one example, it’s noticeable that 21-day realized volatility in USD/CAD, CAD/JPY, EUR/CAD & CAD/CNY in all cases currently stands between 200 bps and 300 bps below their respective 10-year moving averages.

At the same time, spot in each case stands no more than a couple of percent away from the average price for the past two years.

A similar pattern emerges for EUR crosses, with 21-day realized volatility in EUR/USD, EUR/JPY, EUR/CAD and EUR/CNY standing between 200 and 400 bps below the 10-year moving average, while spot prices remain within a couple of percent of the two-year moving averages.

Based on even this brief sampling, it seems that the net impact of the recent caution displayed by the Fed and ECB has been to instill a deep calm on much of the FX markets.

One of the few exceptions to this pattern remains GBP.

While it’s true that the spot prices of GBP/USD, EUR/GBP, GBP/JPY, GBP/CAD and GBP/CNY have all reverted back to within a whisker of their two-year moving averages, and that 21-day realized volatility in all these crosses has declined since the end of January (see chart below), two key differentiating points stand out when compared to EUR or CAD crosses.

The first is that the declines seen in realized volatility over the past week in all the GBP crosses in question have simply brought them back towards their 10-year moving averages. In other words, GBP crosses appear to be behaving normally at present.

The second point to note is that in all cases realized volatility has been trending broadly higher since Parliament returned from its recess last summer.

This is consistent with a pattern noted on a number of occasions in the Aerial View that realized volatility in GBP tends to be at its lowest during periods of Parliamentary recess. Indeed a modest version of this pattern emerged over the New Year as Parliament went away on its break. 

The point this makes is a simple one: over the past few years political factors (hardly surprisingly) have become the prime driver of volatility for GBP.

This, in turn, suggests that with the outcome for Brexit remaining unclear and the clock ticking, there would seem a reasonable chance that the trend higher in realized volatility could remain in place for a little time yet.