Implied euro-dollar volatility is trading at its lowest since 1999
; talk of impeachment; the spread of populist politicians and hung parliaments across Europe. It is hardly surprising that an index from Policy Uncertainty, a geopolitical think-tank, puts global economic uncertainty at its highest since the gauge was created in 1997. By contrast, implied euro-dollar volatility is trading at its lowest since the single currency was born in 1999 .
Derivative contracts indicate that investors think the currency pair, the most traded asset on financial markets, at $400trn annually, will move less than 6% next year. On November 14th the volatility implied by the cost of “call” and “put” options fell below the levels of the serene days before the financial crisis in 2007.Why the disconnect? One explanation is monetary policy on both sides of the Atlantic.
The two central banks’ differing monetary-policy trajectories sent the dollar up— and the euro down. As a result, a greenback buys 22% more euros than in 2014. Now, however, the two currencies have stopped being dragged in opposite directions. Markets forecast no policy change from theA second explanation is that no matter how rocky geopolitics has become, the turbulence pales into insignificance compared with fears during Europe’s sovereign-debt crisis that the single currency would break up.
That nerves have been calmed can be seen in the yield on Italy’s ten-year government bonds. In 2011 it went above 7%; now it sits around 1%. And despite electoral shocks and deadlocks, a break-up of the euro is not on the agenda. The Sentix survey reading is now 6%. But traders should keep their guard up. As in the financial crisis, even when markets seem calm, volatility may come roaring back.
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