Low FX volatility sets the USD/JPY and EUR/JPY bears back
When the EUR/USD is trading in the narrowest quarterly range since the euro appeared, implied USD/JPY volatility is down to its 5-year low, and the Deutsche Bank Currency Volatility index is down to 6.89, the lowest level since July, 2018, funding currencies are facing hard times. According to BofA Merrill Lynch, the main factor, pressing the yen down is its strong sensitivity to better global risk appetite, resulted from the end of the U.S. government shutdown, easing of the US-China trade conflict, as well as the hopes for article 50 extension in the UK that will allow avoiding messy Brexit.
Dynamics of FX volatility
In my opinion, not only politics and geopolitics became the reasons for the current stagnation. The central banks have also contributed to a decline in financial market volatility. First, Jerome Powell by its comments about the Fed’s flexibility and patience encouraged the CME derivatives to reduce the chance for the federal funds rate hike in 2019 to zero. Next, other central banks started sounding dovish. Eventually, investors ceased worrying about insufficient liquidity, the volatility went down, the interest in carry trades increased, and funding currencies are challenged with pressure.
Currently, too bearish forecasts for the USD/JPY, popular after the flash-crash are falling on deaf ears. Goldman Sachs draws some parallels with the 2008-2012, when the pair dropped to level 75.35, affected by a cut in the Fed’s rate and the launch of the QE in the U.S. According to the bank, if the U.S. slides down into a recession, the Federal Reserve will have to ease the monetary policy, and the dollar will be down to ¥60. I don’t think that the U.S. economy should face a growth decline in the near at least18 months. Furthermore, Haruhiko Kuroda has announced that if the yen revaluing prevents the inflation to reach its target rate, the BoJ will expand QE. Although the Bank of Japan holds over 40% bonds, traded in the local market, the government can issue more any time. The fiscal and monetary stimulus can and should be moving in sync in the case with Japan.
Therefore, the USD/JPY bears need the volatility increase and a substantial improvement of global economy growth to be able to restore the USD/JPY downtrend. They could hardly bet on it when China and the U.S. are about to reach an agreement, and German GDP should recover its growth pace in the near future. In addition, Jerome Powell noted that the Fed is willing to carefully monitor the volatility in financial markets if it will threaten the financial stability. Allegedly, the financial conditions are rather important to meet the dual mandate.
I, personally, believe that the yen fans should reduce their appetite. At least, in the first half of the year. The USD/JPY is likely to consolidate in the range of 108.5-112.5; improved economic data in the euro-area will support the EUR/JPY growth up to 127.5 and 130.
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Price chart of USDJPY in real time mode
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