FX Flash – Signs of complacency?

by: Roy Teo

  • EUR/USD volatility has spiked recently…
  • …spill over effects on other currencies limited for now
  • RBNZ signals OCR on hold for a considerable period

 

 

FX-Flash-Signs-of-complacency-9-Feb-17.pdf (49 KB)
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EUR/USD volatility has spiked recently…

In the past week, volatility expectations (three month tenor) in EUR/USD have surged and the options market demand to hedge against further weakness in EUR has increased by one fold. This is due to rising political uncertainty surrounding French Presidential elections in April and May this year.

 

…spill over effects on other currencies limited for now

However, the spill over effects on other currencies in Asia have been surprisingly limited. In our view, financial markets are under-pricing the risks that volatility of currencies in Asia will rise over the next three months given that the EUR has a significant weight in most Asian currencies’ basket. Furthermore, currencies are likely to react when there is greater clarity on US trade policies, fiscal plans and tax reform in Spring.

 

RBNZ signals OCR on hold for a considerable period

As expected, the Reserve Bank of New Zealand (RBNZ) left the Official Cash Rate unchanged at 1.75% earlier this morning. The RBNZ reiterated that a decline in the exchange rate is needed. In addition RBNZ governor said that financial markets were too optimistic in pricing in a rate hike this year. Monetary policy is expected to remain accommodative for a considerable period. Separately there are also encouraging signs of cooling in the Auckland housing market with potentially more macro prudential tools (debt to income ratios) implemented later this year. Finance Minister Joyce has also stated that the Budget on 25 May will have a continued focus on reducing debt as a percentage of GDP. We maintain our view that the RBNZ will shift to a tightening bias only in 2018. As financial markets are still pricing in one rate hike this year,  a weaker New Zealand dollar remains our scenario. Our 2017 year end NZD/USD forecast is 0.66.