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CURRENCY VOLATILITY – TALKING POINTS

  • The DXY US Dollar Index 1-week implied volatility metric reflects a rising trend of expected price action
  • Currency volatility has ticked higher subsequent to the unprecedented lows recorded last month in response to the latest uncertainty surrounding US China trade talks
  • The ‘trade war currency pairs’ like USDCNH and USDMXN are in focus while NZDUSD and USDJPY price action also remains of interest

According to the 1-week implied volatility reading on the DXY US Dollar Index, expected price action has risen from a low of 4.79 percent last Thursday to 5.86 percent today. The recent jump in currency market volatility is primarily owed to the bombshell tweets from US President Trump last Sunday as he threated to raise tariffs on China. The news came as trade talks reportedly broken down between the world’s two largest economies after China reneged on prior commitments.

DXY US DOLLAR INDEX 1-WEEK IMPLIED VOLATILITY PRICE CHART: DAILY TIME FRAME (AUGUST 01, 2018 TO MAY 08, 2019)

US Dollar Volatility Price Chart DXY 1-Week Implied Volatility

Though currency volatility measures remain relatively subdued across major USD crosses, implied volatility on the DXY US Dollar Index looks like it could still trend higher. If a resolution is not found soon between the US and China over their ongoing trade war, the recent jolt of risk has potential of escalating quickly.

FOREX MARKET IMPLIED VOLATILITY AND TRADING RANGES

US China Trade War Uncertainty Continues to Stir Forex VolatilityUS China Trade War Uncertainty Continues to Stir Forex Volatility

With event risk for the New Zealand Dollar now in hindsight, NZDUSD implied volatility unsurprisingly dropped from multi-year highs following a dovish RBNZ cut to its policy interest rate. But, uncertainty over trade talks between the US and China has caused NZDUSD implied volatility to tick higher on balance. This is likely attributable to New Zealand’s high level of dependence on Chinese economic activity – the risk posed by elevated trade deal tension has therefore spilled over to expected price action in the Kiwi.

Similarly, the size of price swings in the Japanese Yen have also increased as of late. Spot USDJPY recorded a string of moves lower amid the recent shift by traders towards 'safe-havens.' The move has been in response to the flareup in trade war uncertainty and the accompanying headwind to global economic growth it likely poses. Consequently, USDJPY 1-week implied volatility currently sits at 7.56 percent – well above its year-to-date average of 5.74 percent.

US CHINA TRADE WAR RISK AND CURRENCY VOLATILITY

While both NZDUSD and USDJPY have been undoubtedly impacted by the latest US China trade war developments, currency price action in the Chinese Yuan and Mexican Peso also reflect heightened market risk and uncertainty. CNY has come under pressure as forex traders react to the reduced likelihood that the US and China reach a deal this week, which has pushed USDCNH above the 6.8000 handle to its highest level since January.

USDCNH PRICE CHART VS IMPLIED VOLATILITY: DAILY TIME FRAME (SEPTEMBER 03, 2018 TO MAY 08, 2019)

USDCNH Price Chart US China Trade War Currency Volatility

The recent move in USDCNH could signal trade talks between the US and China are deteriorating. The decline in spot USDCNH prior its spike higher over the last few days was driven primarily by growing expectations that there would be a Sino-American trade war resolution. With USDCNH overnight and 1-week implied volatility now at 8.41 percent and 7.35 percent respectively, which are the highest readings since December 2018, forex markets are still anticipating heightened price action in the currency pair.

Despite seemingly optimistic tweets from President Trump early Wednesday which stated that Chinese negotiators are still coming to the US in aim of landing a trade deal this week, officials from China have countered that they stand ready to retaliate on Trump’s tariff increase scheduled to take effect Friday. The mixed messages could also be contributing to skyrocketing USDCNH implied volatility.

USDMXN PRICE CHART: DAILY TIME FRAME (FEBRUARY 24, 2019 TO MAY 08, 2019)

USDMXN Price Chart Ahead of Mexico CPI

Shifting attention to the Mexico Peso, USDMXN implied volatility has jumped to 12.47 percent and 9.89 percent respectively for the overnight and 1-week tenors. Since the trade war dampened economic activity between the US and China, Mexico has taken place as America’s top trading partner. Tariffs on Chinese goods stymied the country’s exports to the US which made Mexico a beneficiary of the opportunity to increase its own exports.

However, weak import demand from the US was highlighted in Mexico’s GDP report released late last month in addition to dampened consumer sentiment and business investment. Uncertainty surrounding trade policy from the US – including the pending USMCA deal – has been labeled as a primary factor to recent weakness in Mexico’s economic data.

Moreover, with Mexico’s CPI slated for release Thursday at 13:00 GMT, this high-impact economic event could expose USDMXN to additional price swings over the short term. Judging by USDMXN overnight implied volatility, currency traders might expect spot prices to fluctuate between 18.9458 and 19.1946 with a 68 percent statistical probability over the next 24 hours. That being said, the Peso could weaken further against the greenback if Mexico's year-over-year inflation is reported below expectations of 4.4 percent. Conversely, a better than expected CPI number has potential of pushing USDMXN lower.

TRADING RESOURCES

Whether you are a new or experienced trader, DailyFX has multiple resources available to help you: an indicator for monitoring trader sentiment; quarterly trading forecasts; analytical and educational webinars held daily; trading guides to help you improve trading performance, and even one for those who are new to FX trading.

- Written by Rich Dvorak, Junior Analyst for DailyFX

- Follow @RichDvorakFX on Twitter