DB FX Daily: London Low-EUR/USD Volatility and Weak USD Trend Coexist

[RTFX-Trading]

FX Daily: London
Low-EUR/USD Volatility and Weak USD Trend Coexist
Today's Key Data and Events
USD US existing home sales for June, 5.90 mln expected (14:00 GMT)
USD US Treasury Undersecretary for Intl. Affairs nominee McCormick testifies (14:00 GMT)
USD Fed Beige Book (18:00 GMT)
NZD RBNZ rate decision, 25 bp rate hike expected (21:00 GMT)

Upcoming Event Risks
Aug 3 US non-farm payrolls
Aug 7 FOMC rate decision
Aug. 8: RBA rate decision
Aug. 15: Norges Bank rate decision

Low-EUR/USD Volatility and Weak USD Trend Coexist
As the USD makes new lows for this trend against a host of G10 currencies, one of the more remarkable features of this FX market has been the low levels of not only implied but historic volatility. This has come about despite statistical measures of the EUR/USD trend - such as a VHF filter - moving to the highest levels seen in two years. The divergence is shown in the chart at left below tracks the 6M VHF measure of trend (high-low/sum of absolute daily changes) against the 6M historic volatility for EUR/USD. A combination of smaller daily trading ranges and fewer/less severe corrections to the EUR/USD trend (possibly aided by the growing role of central banks in FX markets given the rapid growth of their assets under management) may have allowed for this divergence to open up. There are a few observations we find of interest: 1) historic volatility for EUR/USD (using USD/DEM pre-1999) over 3M, 6M and 1Y horizons has moved to its lowest level since the late 1970s moving through the more recent low observed in 1996; 2) implied volatility remains above historic volatility in EUR/USD from 1M out to 1Y; and 3) the bottoms of previous sharp declines in historic volatility seen in 1996 and 2002 were only found when the USD trend clearly turned.

Putting all these pieces together, there still does not appear to be a significant inconsistency between an increasing weak USD trend and implied volatility appearing expensive relative to still slumping historic volatility. A short-term respite could be found if the USD decline were to become more disorderly in an environment of accelerating concerns over the US credit cycle. But absent such a development, a bottom in volatility may require a turn in the USD trend which still appears some distance away.