Expect more FX volatility

Forex News and Events

Expect more FX volatility

The SNB's decision to abandon the EURCHF minimum exchange rate should spark a period of extreme volatility in FX markets. The proverbial "gloves are off" for central banks actions and we should expected more impulsive and radical strategies. This week the ECB is anticipated to “up the ante” by announcing a significant sovereign QE program. We suspect that the decision will be well above the €500bn currently expected by the market. Speculation that the ECB will use national central banks to conduct bond buying programs with a capped upper limited is gaining market support. However, the size and scope of the program is still very much in flux and uncertainity will increase EUR vol. The SNB might have in effect tightened financial conditions, yet the global trend is for a deeper easing bias. Last week the Bank of India unexpectedly cut rates and we are now expecting that the Bank of Turkey will follow suit. The BoJ and BoC's meetings this week are not expected to announce any new stimulus yet will maintain an easing bias. Historically, quickly shifting policy by central banks are the primary determinate to FX volatility.

Cynicism in Central Bank communications

Interestingly, this round of aggressive policy actions comes with a level of renewed skepticism over central bankers transparency. A lot has been made, and rightly so, of SNB Danthine comments last Monday that the EURCHF floor was the “cornerstone” of monetary policy and SNB Jordon’s statement that substantial thought had been put into the decision. Two comments that seem to be diametrically opposed. Either way, blind faith in central bank communications has also been abandoned. And with the market second guessing every word, FX volatile is poised to increase. Also say goodbye to the significance of “forward guidance.”

Who’s Next? EURDKK?

The unprecedented move by the SNB to abandon the minimum exchange rate on EURCHF, has raised the question as to what policy regime is next. The EURDKK peg looks like an enticing candidate. With Denmark offering a higher interest rate than Switzerland (-0.5% and -0.75%) and lower volatility, we could see further capital flow redirected to DKK. The Denmark National bank has already conducted heavy FX intervention to help stabilize and maintain the lower bound of EURDKK with roughly DKK20.bn in the last few months. Obviously, we will see additional interest rate cuts and larger FX intervention in the near term. However, as seen with EURCHF negative interest rates, this strategy has a limited effect in dissuading safe-haven/ risk averse flows. Yet unbridled balance sheet expansion through direct FX intervention can quickly grow past the point of national economic safety. With the ECB QE announcement and Greek elections right around the corner, we suspect that the DN will begin to contemplate the EURDKK peg.