Euro: Volatility divergence points to future swings against US Dollar – Commerzbank

Commerzbank’s Volkmar Baur highlights that EUR/USD realized 3-month volatility has dropped to near five-year lows. He links part of the calm to highly correlated central bank rate expectations driven partly by oil prices, but notes this cannot fully explain the move. Importantly, implied volatility now stands more than one percentage point above historical volatility, suggesting markets expect EUR/USD volatility to rise.

Low realized, higher implied volatility

"And despite all this, the realized volatility of the EUR/USD exchange rate over the past three months fell yesterday to 4.53%, it's near the lowest level in nearly five years. Not only that. Over the past nearly 20 years (Bloomberg data goes back to May 31, 2007), there have been only three instances in which the EUR/USD realized 3-month volatility was even lower than it is currently. It has been lower than yesterday’s level on only 2.2% of trading days."

"And a comparison with other G10 currencies also shows that, for the most part, a lower exchange rate volatility against the euro has occurred in those currencies where central bank expectations this year exhibit a higher correlation than last year."

"So there appears to be yet another factor keeping volatility low this year. While the market’s focus on oil prices seems to play a role, it cannot fully explain the current very low volatility."

"One thing, however, still stands out: Normally, historical 3-month volatility and expected volatility for the next 3 months (as implied by option prices) move largely in tandem. Over the past nearly 20 years, 80% of the movements in implied volatility can be explained by historical volatility. At the moment, however, a certain divergence is evident. Historical volatility is more than one percentage point lower than implied volatility. "

"Considering the low overall level, the difference between the two volatility indicators has been greater on only about 4% of trading days over the past nearly 20 years. So even though historical volatility has been low over the past three months, the market expects it to rise soon."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor. Know more.)