As increasingly accommodative monetary policy becomes the standard for central banks around the world, we continue to see increased volatility in global currency markets. This volatility has been followed by record breaking trading in exchange traded currency derivatives. CME Group’s FX futures volume is up 16 percent over last year, and FX options are up 77 percent.
The unprecedented changes in monetary policy around the world have largely driven this volume and have made hedgers and speculators alike realize that currency risk can no longer be an afterthought. It is a new market dynamic, and when analyzing recent action in currency markets and continually easy policies in the world’s largest economies, we expect that increased volatility is likely to continue.
Bernanke: Nothing Set in Stone
This became even more evident after Federal Reserve Chairman Ben Bernanke’s testimony before congress on July 17. Although Bernanke and the Fed have said they anticipate the taper in bond buying to take place later this year, Bernanke made it clear in his statements that this is not set in stone. In his testimony before congress, Bernanke reiterated that the decision of when to taper back the $85 billion a month bond buying program will not be based on a predetermined timeline, but on the strength of the economy and growth targets. The Fed chairman even went so far as to say the scale of the program could increase if targets for economic growth are not met by next year. He also made it clear that rates will not be going up anytime soon.
Draghi: Shrink the ECB Balance Sheet
Amidst speculation of when the taper will actually begin, European Central Bank (ECB) President Mario Draghi took action to protect the still fragile Eurozone from a possible rise in bond yields led by U.S. treasuries. While laying a roadmap for future policy in Europe, Draghi reiterated his desire to continue shrinking the bank’s balance sheet, albeit while maintaining low interest rates in the Eurozone for an extended period of time.
Although the consensus among analysts is that benchmark rates in Europe will remain unchanged until 2015 at the earliest, the ECB has made it clear this policy will be reassessed every month. Despite these actions taken by Draghi, the Euro wasn’t entirely immune to concerns regarding Bernanke’s statements, slipping lower as the Fed chairman spoke to congress.
Carney: Maintain the Current Scale
Mark Carney, the new governor of the Bank of England (BoE), also attempted to calm markets last week when the BoE released an uncharacteristic statement explaining that the rise in rates was not warranted by developments in the economy. Despite Bernanke’s testimony, the British Pound showed notable strength versus the dollar, as British unemployment numbers released July 17 showed their sharpest decline since June 2010.
The release of the July BoE minutes also bolstered confidence as committee members unanimously voted in favor of Carney’s plan to maintain the current scale of their quantitative easing program. Although Carney and the committee stated they believe the rate of the recovery is continuing to improve, it is still widely believed the economy is fragile. This has many analysts believing the formerly dovish members of the committee who sided with Carney will simply push for more accommodative policy at the next meeting. If this speculation intensifies, it could lead to more volatility in the pound.
Aussie and Yen Active
The Australian Dollar showed relatively little movement in the midst of the currency frenzy related to Bernanke’s meeting with Congress, which is to be expected, considering Australia’s broader concerns regarding an ongoing Chinese slowdown. The currency enjoyed a landmark showing July 17, after the release of the most recent Reserve Bank of Australia (RBA) minutes. The RBA softened its previously ardent tone regarding the possibility of a rate cut next month.. The currency has maintained, and even built on, these gains in the wake of Bernanke’s talk with little volatility.
The Yen has been a revealing magnifier of generalized market uncertainty before, and has acted as such again in the buildup to, and the wake of, Ben Bernanke’s statements before congress. The unwinding of the great Yen short trade has played a role in maintaining the currency’s value in recent sessions. The popularity of the Yen trade means that volatility in the dollar will affect the Yen to a larger degree than other pairs, and that more whipsawing in the Yen could be on the horizon.
Even with Bernanke, Carney, and Draghi taking steps to clarify the future of monetary policy in their respective economies, they have all made sure to leave themselves room to modify or change entirely the roadmaps they have laid out. While further clarification should help to calm market volatility in the short term, it also means that any shift in future policy could come as a surprise to markets.