Three Volatile Currency Pairs Today

US dollar - FT article cites key officials’ view on dollar weakness; interest rate decisions deliver nothing but whiplash

We noted earlier this week how implied options volatility across major currency pairs was declining. That fact is pertinent given the dollar’s latest recovery and in context of a recent G7 communiqué that pointed to unwarranted exchange rate volatility. What they were really saying was that freefall for the value of the dollar was a hazardous path and if it continued, as evidenced by rising uncertainty as reflected by the options market, they would be forced to intervene.

Thursday’s currency market is abuzz with a sober reinforcement of that tone in today’s Financial Times. Unnamed officials in Europe and the U.S. share the same harmony in fanning the flames of the nascent dollar revival. At the time the importance of the communiqué was vastly understated in forex circles. Few quickly heeded the warning, and the majority blindly assumed that the G7 was powerless to conduct currency intervention.

We recall noting at the time that any intervention would be less meaningful with the euro at $1.60 than it would be at $1.53. So far the G7 statement has raised enough questions surrounding future intervention so as to curtail forex appetite for compounded dollar weakness.

Our point is that it’s easier to push the giant snowball off the middle of the slope than it is to struggle with an uphill fight before intending to release it. In that sense the market has probably correctly concluded that the G7 means business, but would prefer to let the market arrive at the same conclusion.

The FT article also highlighted a key market obstacle for dollar recovery and one that may well be in the process of a thaw of its own. The paper noted observations by officials who claimed that speculators were confused over short-term dollar weakness and longer-term U.S. economic recovery.

We think this is an extremely salient point. For month after month, currency speculators have literally printed money by pointing to widening yield differentials against the dollar thanks to the unknown depths of economic decline ahead. This has been evidenced by the bear market for financial stocks as banks wrote down billions of dollars and simultaneously felt the stresses of skyrocketing borrowing costs in the financial markets.

It’s been easy for short-term speculators to punish the dollar at each and every opportunity. But now that both monetary and fiscal responses are in place, the game is different for them and indeed longer-term players are seeing through such pessimism.

Any player in the market today carrying a short dollar position in the hope that the same short-term rationale exists may be susceptible to a growing chorus from the forex thinkers who are starting to see the redundancy of an argument for U.S. depression talk.

Investors are taking seriously the fact that the Fed may have paused in cutting rates, while the money market is ever-so-gently thawing. That’s allowing yields across the Eurodollar futures strip to decline. With three-month Libor now down to 2.73%, we’re also seeing a greater willingness of money traders to push forward rates lower, indicating some clearance ahead of the liquidity logjam.

Euro

Following an unchanged tone to interest rates earlier today, the euro has rebounded slightly up to $1.5435 after slumping to an eight-week low at $1.5312 this morning. Option implied volatility rose from 9.8% to 10.3% on the PHLX World Currency options as a result of the climb in the euro. We note some fresh put positioning today in the September contract between strikes at $1.57 through $1.59.

British pound

The Bank of England also kept rates on hold and allowed for a rally in the pound’s fortunes against the dollar. We are increasingly hearing more longer-term pessimists on the fortunes of the United Kingdom, whose fortune is increasingly been coupled closer with those of the U.S. than to Europe. The pound reached $1.9621 before dropping a half cent to the dollar.

Option implied volatility on the PHLX pound options rose from 8.9% to 9.1% this morning. There is fresh put buying activity in the September contract between $1.85 and $1.87 strikes. On the September contract there is some activity in $2.02 calls and $2.00 puts, which could be straddle posturing.

Canadian dollar

Despite some stronger data out of Canada earlier this week indicating robust domestic spending, the U.S. unit is undergoing a strong resurgence in demand having bounced off parity yesterday. So far today the greenback is taking a breather from a run to C$1.0145 and currently buys C$1.0125. Option implied volatility has risen slightly to 10.8%.

Rebecca Engmann Darst contributed to this report.