Dollar Volatility Soars With Fresh Covid Lockdowns in Europe

(Bloomberg) -- Volatility in the currency markets is back with a bang, stoked by Europe coming face to face with lockdowns all over again. 

The component currency-weighted three-month volatility index of the dollar has shot up to levels last seen in March, when markets were roiled by surging Treasury yields. At current levels, traders are bracing themselves for average daily moves of about 0.42% on the Dollar Index over the next three months.

EUR/USD has scope to weaken toward 1.1131, though the pace of declines is now picking up on the back of Austria announcing a nationwide lockdown and Germany refusing to rule out a similar prospect.  

That, of course, means that the greenback, which was already rallying, gets an additional tailwind. A measure of how intense the flight into the dollar is may be seen from the charts, where the currency is around the most overbought it has been in weeks. 

Which brings us back to the volatility question again. While currency volatility may stay uncorked for a while yet, it’s hard to imagine a scenario where we re-visit levels seen before the financial crisis. 

• There has been a regime shift in volatility. Currency volatility in key pairs like EUR/USD surged enough to factor in daily moves of as much as 1.6% in the aftermath of the global financial crisis. Yet even at the height of last year’s tumult in the financial markets, the premium pricing was just about 0.8%.
• What has prompted this shift? In major part, central banks have become the only game in town. Gone are the days when their mandate was about stoking employment and keeping inflation concerns in check. In the post GFC-world, they have become the Masters of the Universe, eager to save the financial markets at the first hint of a crisis.
• As a result, barring a cataclysmic, multi-standard deviation risk event, the prospect of profits for volatility traders is slimmer, which has killed the markets.
• NOTE: This was a post on Bloomberg’s Markets Live blog. The observations are those of the blogger and not intended as investment advice. For more markets analysis, run MLIV on the Bloomberg Terminal.

©2021 Bloomberg L.P.