Currency traders are gearing up for a ‘volume killer’ summer after the Fed

According to options traders, investors were expecting greater currency volatility in the coming months as central banks made multiple changes to interest rates, but they were likely to be disappointed.

Currency markets had started to show signs of turbulence when the Australian dollar, euro and yen rose by about 1% after the US reported weak inflation data on June 12. However, those moves fizzled out after Federal Reserve Chair Jerome Powell forecast a one-day interest rate cut this year, and JPMorgan’s Global FX Volatility Index fell for a second day on Thursday – although concerns over elections in France pushed the index higher on Friday.

Investors now face the prospect of currencies remaining range-bound throughout the Northern Hemisphere summer, offering few profitable trading opportunities.

“The Fed’s decision has made the market data-dependent and essentially reduced the likelihood of a quick rate cut over the summer to almost zero,” said Ruchir Sharma, London-based global head of FX options trading at Nomura International Plc. “As a result, the market is unlikely to break out of its recent ranges over the summer months.”

Trading strategies designed with such an approach in mind could “meaningfully” reduce volatility in the short term, Sharma said.

The Fed kept its benchmark rates unchanged as widely expected, but signaled it now expects to cut interest rates by 25 basis points once this year, compared with March estimates that predicted a 75 basis point cut.

“This announcement is likely to reduce volatility in the short to medium term,” said Nathan Swamy, Citigroup Inc.’s Singapore-based head of foreign exchange trading in the Asia Pacific region. “The Fed has removed some of the uncertainty about future policy paths, and that should mean that implied volatility in general will be lower.”

Event Watch

A gauge of expected volatility in the Bloomberg Dollar Spot Index had climbed back toward its five-year average in recent weeks, having trailed historical levels for most of the year. On average, it has tended to climb over the Northern Hemisphere summer.

Traders are now keeping an eye on upcoming events such as the French election or U.S. economic data such as core PCE — the Fed’s preferred measure of inflation — to see if they could trigger big movements in currencies. While the U.S. election looms as a volatility catalyst later this year, Goldman Sachs Group Inc. has suggested that the first presidential debate on June 27 has the potential to trigger volatility.

The announcement of President Emmanuel Macron’s sudden election in France has shaken bond markets, pressuring the euro and boosting safe-haven currencies such as the dollar and Swiss franc. After falling on Wednesday and Thursday, the JPMorgan Global FX Volatility Index jumped on Friday.

“It’s quite possible that the first debate will help focus attention more clearly on the election in the summer, possibly even earlier than historical experience suggests,” New York-based strategist Vicky Chang wrote in a note on June 13. “We think the election is better positioned than usual to receive that kind of information before the event.”

If volatility remains low, that would be good news for carry traders, who borrow currency where rates are low and invest where rates are higher, often in emerging markets. They have come under pressure recently because of unexpected changes in elections from Mexico to India.

The Fed has raised expectations of more currency volatility, at least in the short term, according to Kelvin Yeoh, portfolio manager at Blue Edge Advisors.

“CPI and FOMC came out on the same day as Powell calling himself the Oppenheimer of the market recession, but his opening statement might have been ‘Now I am death, the destroyer of volume,’” he said. “It is a volume killer for now, but honestly it is not clear yet if the storm has passed or we are in the eye of the storm.”