Trade War Kills Currency Volatility, Leaves Analysts Flummoxed - BLOOMBERG

JULY 11, 2018

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  • Measures of realized volatity are close to the lows for year
  • Commerzbank stumped on dollar, Rabobank says same on yuan

Foreign-exchange traders are struggling to know which way to lean when it comes to betting on the escalating global trade war.

While the U.S. and China have been exchanging blows over tariffs in recent weeks, swings in major developed-market currencies have remained muted, and opinion is divided about what might constitute a haven if tensions escalate. Measures of realized volatility are close to the lows for the year and well below where they were during Italy’s recent political crisis. That may also be acting as a drag on option-implied volatility.

A global trade war with the U.S. at the epicenter has upended some assumptions about how certain currencies move in times of risk aversion, and that’s left a number of strategists flummoxed. Standard Bank said Wednesday it’s disinclined to make new forecasts given the murky outlook, while Societe Generale SA said it’s struggling to figure out why the yen isn’t acting as a haven. Commerzbank AG said it was stumped about where the dollar is headed from here.

“A problem that we have found all this year is that the sharp and sudden sentiment shifts caused primarily by trade tensions are stopping many currencies from trending in a clear way and that has made position-taking more difficult,” Steve Barrow, head of currency strategy at Standard Bank in London, said in a research note. “There are few signs of this abating and, perhaps not too surprisingly, our currency indicators tend to be both mixed and weak.”


A big part of the difficulty, Barrow said, comes from trying to work out if the trade conflict is going to also turn into a currency war, and whether the U.S. actually wants a weaker dollar or a stronger one. He argues that while embracing a weakening policy may be an effective way to stage a currency battle against the European Union, China is more likely to succumb to U.S. pressure if the greenback is strong because it would lift the cost of debt and could trigger capital flight.

Then there’s the question of the yuan, which will intermediate the terms of trade between the world’s two largest economies. The Chinese currency has been weakening since mid-June as tensions intensified and it dropped to the lowest versus the dollar since August on Wednesday.

Michael Every, a macro strategist at Rabobank, said the market is still seeing the yuan’s weakness as a “catch up” rather than a currency war, which makes the outlook difficult to gauge. That could still change if the trade war gets worse, the Federal Reserve raises interest rates and China’s economy slows, he wrote in a research note published Wednesday, in which he maintained a forecast for the currency to continue to weaken.

The other big question hanging over markets is what direction will haven currencies take from here. The yen and the Swiss franc retreated on Wednesday, extending losses versus the dollar for the past month. Kit Juckes, a Societe Generale strategist in London, described the yen as “the pick of the currencies within Asia” in a research note published Wednesday.

“I really don’t know why the yen isn’t stronger,” Juckes wrote. “My default position is to believe that it will be, in due course.”

Viraj Patel, a strategist at ING Groep NV said in a phone interview that the limited spillover effect on currencies has been an "unusual phenomenon, but one that equally we’ve become accustomed too." He’s forecasting the dollar to continue to strengthen against emerging-market currencies, but to stay flat against the euro and yen.

"Trying to bet on which country will lose more or less, it seems kind of a trivial type of experiment to do within an FX space,” Patel said. For major currencies, “it’s going to kind of be a slow burner."

— With assistance by Sid Verma


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