EUR/USD Implied Volatility Drops to Multi-Year Lows
EUR/USD CURRENCY VOLATILITY – TALKING POINTS
- Spot EUR/USD has fluctuated within a relatively tight trading range since late 2018
- Lack of currency volatility in spot EUR/USD has weighed on future expected price action
- EUR/USD implied volatility across the 6-month and 12-month measures have plunged to the lowest level since July 2014 and June 2007 respectively
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Currency volatility has drifted lower over the last few months and is a trend largely driven by lack of price action in spot EUR/USD – the world’s most traded forex pair. Seeing that volatility generally begets more volatility, it is not surprising that EUR/USD implied volatility measures have taken a nosedive with some tenors recording fresh multi-year lows.
EUR/USD IMPLIED VOLATILITY CHART: DAILY TIME FRAME (JULY 03, 2018 TO JULY 03, 2019)
In fact, EUR/USD 6-month and 12-month implied volatility readings touched their lowest level since July 2014 and June 2007 respectively while shorter durations have plunged similarly. Lack of price action in spot EUR/USD over the last few months could be attributed to dovish central bank expectations.
According to overnight swaps, traders are currently expecting both the European Central Bank (ECB) and Federal Reserve (Fed) to ease monetary policy over the coming months primarily in response to deteriorating economic data like slowing GDP growth and weakening labor markets. As such, a “battle of the doves” appears to have emerged with the ECB and Fed communicating their stark readiness to act and shore up their economies.
While heightened dovishness by the ECB and Fed could continue dragging EUR/USD implied volatility lower over the short-term – particularly with recent news that IMF’s Christine Lagarde will replace ECB President Mario Draghi at the end of October and US President Trump’s Fed nominations – the extremely low readings of EUR/USD implied volatility risk rebounding higher toward historical averages.
SPOT EUR/USD PRICE CHART: WEEKLY TIME FRAME (JULY 31, 2016 TO JULY 03, 2019)
Using the current 6-month implied volatility reading of 5.38 percent for spot EUR/USD, the currency pair’s 1-standard deviation estimated trading range can be calculated. As such, spot EUR/USD is expected to trade between 1.0857-1.1709 over the next 6-months with a 68 percent statistical probability. It is noteworthy that the estimated trading range aligns almost perfectly with the 76.4 percent and 38.2 percent Fibonacci retracement levels of the forex rate’s ascent from 1.0340 to 1.2556 from January 1, 2017 to February 11, 2018.
These technical levels of confluence will likely provide an additional layer of support and resistance respectively. That being said, the short-term trading range in spot EUR/USD recorded since November 2018 – roughly between the 1.15 and 1.12 handles – poses a challenge for volatility as the technical levels could limit sharp swings in spot EUR/USD.
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