USD: Deceptively low USD volatility – Commerzbank

Sentiment regarding the US Dollar (USD) brightened significantly. As yesterday's events showed, this positive sentiment proved to be extremely fragile. An outplacement company reported unusually high layoffs last month. This led to renewed concerns on the market about the situation on the US labor market, Commerzbank's Head of FX and Commodity Research Thu Lan Nguyen notes.

Early rate cycles bring volatility to EUR/USD

"After the last Fed meeting, Fed Chair Jay Powell played down the recent sharp slowdown in employment, citing the still low unemployment rate, and left all options open for the December meeting. Any data that suggests a more rapid deterioration in employment than the central bankers assume thus increases the chances of further rapid interest rate cuts."

"Sudden shifts in sentiment such as those seen yesterday are not unusual at the beginning of an interest rate cycle. After all, uncertainty about how quickly and how sharply the central bank will change interest rates is greatest at the outset. As the figure below shows, significant increases in implied EUR/USD volatility were observed at the beginning of the last US interest rate cycles. I am therefore sceptical as regards the recent significant decline in exchange rate volatility priced into the options market."

"The decline is likely to be partly attributable to the fact that, due to the US government shutdown, no official data is currently available that would allow for a more reliable assessment of the monetary policy outlook. However, this also means that once the shutdown ends and a large number of official figures are due to be published, there is a risk of a very significant reassessment of interest rate prospects and thus also of the US dollar."