Slumbering forex markets confound traders, prompt fear of rude awakening

Deutsche Bank's Currency Volatility Index has declined since 2017 to its lowest in four-and-a-half years.
Deutsche Bank's Currency Volatility Index has declined since 2017 to its lowest in four-and-a-half years.PHOTO: REUTERS

LONDON (REUTERS) - Currency markets are so listless, the head of European foreign exchange (forex) sales at Nomura has taken to selling bonds instead.

Pitching currency opportunities to clients is pointless without the big exchange rate swings that pique investor interest, Fabrizio Russo told Reuters.

"There's no point. When markets are quiet there's really no point in calling (clients)."

"I've been selling them bonds," he added, contrasting the slow pace with the frenzied buying of European government bonds in recent weeks.

Russo's experience is echoed in dealing rooms across London, the main trading centre for the US$5.1 trillion-a-day forex market. Some trading veterans said it reminded them of conditions before the 2008 global financial crisis erupted.

Deutsche Bank's Currency Volatility Index has declined since 2017 to its lowest in 4-1/2 years and currently stands at about two-thirds its levels of early 2019 and less than half the peaks of three years ago.

Low 'vol', shorthand for implied volatility gauges embedded in options markets, reflects relative order in exchange rates - markets without the big pricing gaps that offer money-making opportunities and increase demand for hedging products.

And with central banks expected to extend their decade-long stimulus programmes, the forex funk could be extended as short and long-term interest rates converge towards zero again and rate gaps between major currencies shrink once more.

Just how resistant currency markets are to shake-ups was evident on June 18, the day European Central Bank President Mario Draghi shocked markets by signalling more rate cuts may be coming. He sent 10-year German bond yields to record lows, while French borrowing costs fell below 0 per cent for the first time and European shares jumped 2 per cent.

But the euro? It slipped 0.4 per cent, a tiny move by historical standards and only its fourth-largest daily change in June.

Euro/dollar, the world's biggest currency pair, has not traded below US$1.10 or above US$1.16 since October, a range of little more than 4 per cent, even with trade war and recession threats and the U.S. Federal Reserve's U-turn on interest rates.

In contrast, volatility in US Treasuries has surged to its highest since April 2017, while the equity market "fear" index VIX remains above multi-year lows plumbed in 2017.

"The Fed is totally in play and rates are moving drastically and there's no translation to forex. It's odd to see," said Russell LaScala, Deutsche Bank's co-head of foreign exchange.

"It's become this very sleepy asset class."


One question is whether this unusual calm could end in panic, as in March 2008 when Deutsche's volatility index rocketed to over 12, after spending most of 2007 stuck below 7.

Options show little sign of that. One-year implied euro-dollar vol has slumped to 6, from nearly 8 in January .

But while there's no shortage of political and economic uncertainties arguing for a volatility resurgence, the change of market behaviour could sow the seeds of its eventual end.

Many traders have been lured into 'short vol' strategies whereby, for example, they buy an option earning them a "premium" so long as euro/dollar remains between US$1.11 and US$1.15 for the next month. If volatility surges, smashing the currency out of its range, traders lose their original payment.

In 2017, becalmed US stocks tempted many on Wall Street into short vol bets that eventually exploded in February 2018 - dubbed "volmageddon" - on the relatively minor trigger of a punchy US inflation reading.

"It's a very risky strategy. But at the same time it's paid off for four years," Deutsche Bank's Mr LaScala said, describing recent late entrants to the vol selling trade as "tourists".

Scant volatility is also prompting bond and equity managers to cut back on hedging, typically used to insure against losses.

Nomura's Mr Russo said investors who had held yen as a risk hedge were disappointed when the Japanese currency didn't rise more during December's equity rout. It firmed around 3 per cent that month while Wall Street fell 10 per cent.

Many have since stopped using yen, long viewed as a safe haven, to hedge portfolios, he said.

Similarly, the euro, often a hedge against European risks, has barely responded to recent selloffs in Italian bonds.

Hedge funds have also trimmed bets on currency direction.

Nomura's Russo said the Fed's dovish turn has sparked some interest, especially from investors prepared to bet the dollar had peaked. He has been telling clients "they have to be ready" if volatility does return.


Low volatility has been bad for bank earnings. Daily average currency trading volumes have been down about 10 per cent annual from last year in recent months on platforms such as CLS.

With trading profits heavily reliant on vol, investment banks' forex revenues were just US$16.3 billion last year compared to US$18.4 billion in 2015, data firm Coalition estimates.

One senior trader said forex revenues at his London-based bank have shrunk 5 per cent a year for several years.

"You can't make any money out of something that doesn't move. Low volatility is fine but very low volatility is not," said Richard Benson, head of portfolio investments at asset manager Millennium Global.

With investors on the sidelines, traders are spending more time at client lunches and less time transacting.

James, an forex trader for a British bank who asked for his surname not to be used, sometimes listens to music at his desk.

"Looking at these stubbornly stable prices on my screen ... It's like watching paint dry," he lamented.