Complacency invites chaos

Volatility in FX markets is at a 1-year low in a signal that traders feel confident in their outlooks into the end of the year.

This is understandable, the Fed has signaled their intent to continue cutting the US interest rate this year in the face of a weakening labour market, whilst the Bank of England seems set to hold rates at 4% into years end as inflation continues to rise.

However, this confidence risks turning to complacence, especially given just how heavily stretched the market is in certain positions. 70% expect two 0.25% interest rate cuts more from the Fed this year, meaning a cut from the two remaining meetings.

No change in rates is expected from the Bank of England until April of next year, although the volume of options expiring in November, just ahead of the budget, does suggest some awareness of the intense fiscal risks Sterling faces.

The Fed, despite the relentless pressure from the White House, could still have a change of heart, should tariff fueled goods inflation continue and especially if we see services costs start to rise in tandem. Stronger than anticipated jobs data is also a real threat to such a sleepy outlook.

The Euro, presently seen as a pillar of stability amidst an ocean of uncertainty, could see its presently rosy outlook turn should Eurozone unemployment start to rise.

With the market’s current positioning, just in EURGBP, being 80% biased to a stronger Euro, even a small surprise could turn conviction to flight. EURGBP just last week hit its strongest level since July, but risks remain, especially when the bets start to look one-sided.

Beyond the US, UK and Eurozone, the world still has plenty of live wires firing off, from the widening creaks in the Chinese economy, to gradually rising commodity prices, risks abound and it is just a question of which pain point will dominate headlines in the near future.