(Bloomberg) — The market horizon is littered with risks that could trigger bigger moves in currencies even as the Federal Reserve and other central banks double down on the policies that have anchored volatility close to historic lows.
Growing concern about the prospect of a second wave of coronavirus turmoil and potential variations in how well different economies bounce back from recession have helped fuel a recent uptick in foreign-exchange volatility, while uncertainties also swirl about China-U.S. tensions, America’s presidential election and what path the European Union chooses to take. And with the recent rally in riskier assets in reverse gear, the road ahead appears even more grim.
A Deutsche Bank (DE:) gauge of foreign-exchange implied volatility is trading near a three-week high, up from record lows in February before the coronavirus pushed it to a decade high in March. Traders were stunned earlier this year as the pandemic shock fueled volatility following a period where price swings mostly languished amid easy monetary policies.
Given the varying economic growth rates, “there will be a higher base level of volatility unlike what we saw pre-Covid when the global economy was very synchronized via trade flows, ” said Jordan Rochester, currency strategist at Nomura International Plc.
Central banks have helped to suppress volatility by using their balance sheets for large-scale asset purchases, driving investors into riskier asset classes for higher returns.
But with economic concerns reemerging, strategists see plenty of opportunities to take advantage of expected spikes in volatility.
Read more: Stocks Tumble Most in 12 Weeks on Economy, Virus: Markets Wrap
For Citigroup’s Tom Fitzpatrick, investors should buy six-month euro-dollar call options, betting on the common currency appreciating against the greenback, while Valentin Marinov, head of Group-of-10 FX strategy at Credit Agricole (OTC:), recommends volatility bets on key commodity-linked currencies.
Marinov is “looking for triggers of risk aversion and FX volatility beyond the tranquil months of June and July.” He sees value in buying six-month options on the U.S.-Canadian dollar and Australian-U.S. dollar pairs due to inverted volatility curves.
The so-called inverted volatility term structure shows hedging is relatively less expensive in volatility terms for longer tenors. He also sees demand to hedge against big moves around the U.S. presidential election scheduled for Nov. 3.
SEB’s strategist Lauri Hälikkä suggests investors start buying euro-dollar volatility as risks of the common currency further appreciating against the greenback increase. The euro is up 1.8% this month versus the dollar as the region’s leaders introduce new stimulus to bolster the economy.
“There will be virus differentiation across countries that will have profound economic effects,” said Deutsche Bank chief international strategist Alan Ruskin. That should help to “limit the decline in volatility,” he said.
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