Currency traders bet on market volatility returning with Trump

After years of benign moves, a gauge of one-year volatility on the euro-dollar exchange rate surged after the election.

Currency traders are betting that Donald Trump’s policy agenda is about to jumpstart volatility in the $7.5 trillion-a-day foreign exchange market.

After years of benign moves, a gauge of one-year volatility on the euro-dollar exchange rate surged after the election. Hedge funds are scooping up options contracts that pay out if currency swings increase and strategists have dramatically revised their currency forecasts.

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While it’s not yet clear how quickly Trump will implement policies such as trade tariffs that could cause significant pain to currencies like the euro, investors are pretty certain that unpredictability will be a major feature of his term in office. There’s also the unknown factor of how countries will respond to Trump’s measures and what impact those countermeasures will have on markets.

“It’s an environment where FX becomes particularly interesting,” said Julian Weiss, head of G-10 vanilla FX options at Bank of America, adding that demand for longer-term products has picked up. “Any hedge fund across the globe, even if they have an equity focus, all of a sudden we’re seeing FX exposure being put on.”

The trend marks a sharp turnaround from the past few years when central banks raising and then cutting interest rates in tandem ushered in a period of extreme calm. Now, with Trump’s America First policies expected to fuel inflation at home, traders expect a widening policy gulf between the Federal Reserve and its peers, which will break major currency pairs like the euro-dollar out of their tightest range in years.

Banks have slashed their forecasts for the currency pair in the wake of the US election, anticipating a slide toward parity.

“We would expect Trump’s likely policies to create greater room for macro-economic divergence, which would lead to bigger FX moves,” said Dominic Bunning, head of G-10 strategy at Nomura.

Market projections for a stronger dollar under Trump also support the case for elevated hedging costs because correlation between the greenback and volatility is at its strongest when the US currency is in high demand.

Options traders at NatWest Group Plc say activity has been particularly concentrated around bets on euro, Aussie dollar and yen moves versus the dollar, while traders at UBS Group AG note that wagering on Chinese yuan weakness has also been a popular play.

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“Currencies with the greatest perceived exposure to tariffs and Trump’s policies will continue to be favored from a volatility perspective,” said Henry Drysdale, co-head of currency options trading at NatWest.

Of course there’s a risk that much of the expected turbulence gets so baked in to market pricing in the run up to Trump’s inauguration that swings in the longer term turn out to be softer than expected. That’s broadly what happened during Trump’s last presidency, partly because policies like trade tariffs ended up taking longer than expected to be implemented.

This time round, Republican control of the House and the Senate may mean that policies get implemented harder and faster. Then there’s the wild card of day-to-day currency moves in response to regular Tweets from the president, a state of affairs that traders remember all too well from his last term in office.

“2025 will be a year of volatility and uncertainty,” said Shahab Jalinoos, global head of currency research at UBS. “We don’t yet know what till transpire under Trump and there are so many crosscurrents.”

© 2024 Bloomberg

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