Lower volatility drives flows into higher yields
AS a result of lower FX market volatility and high daily trading volumes, combined with rock-bottom dollar yields, traders have been driven into long risk positions in the hunt for gains.
Higher-yielding Canadian and Aussie dollars and even the euro have been targets for trading on the risk trend. This trend was given another boost yesterday as news of another round of the European Central Bank’s Long-Term Refinancing Operation (LTRO) lessened demand for the safety of the dollar.
The pumping of cheap credit from the ECB comes after the Bank of England (BoE) and the Bank of Japan (BoJ) announced in recent weeks that they would be expanding their quantitative easing programs.
DOLLAR OUT OF FASHION
The flattening of FX market volatility is not just a result of the ECB’s LTRO2 but part of a longer term trend. FX market volatility indices are at their lowest levels since August 2008 (See the chart, below right, based on the FX options market volatility expectations.)
After the Swiss National Bank imposed capital controls on the franc in September last year, the dollar has acted as the haven currency of choice. But with volatility on the wane, so is demand for the dollar as a “safe” currency. According to Christopher Vecchio, currency analyst at DailyFX, a prolonged period of this calmness could lead to a continutation of the current euro-dollar rally, as well as gains for the Aussie dollar commodity currency: “Recent price action supports this theory, as euro-dollar broke above a key descending trendline coinciding with the psychologically significant $1.3200 level.” Vecchio adds: “We expect that the dollar may fall further if recent market trends continue.”