When will the sluggish volatility be broken?
Morning FX
When will the stagnant volatility finally break?
At the June FOMC, Waller removed forward guidance, stating there would be no forecast given for the future path of interest rates. Furthermore, at the Sintra ECB Forum on July 1, a complete and formal announcement was made: “the era of forward guidance has ended.”
At the same forum, the ECB President also proposed abandoning traditional forward guidance:
"I have always regretted being constrained by traditional forward guidance in the past. We have now completely abandoned path-based forward guidance—that is, promises like ‘interest rates will be maintained until a certain point in time, with pre-locked policy paths.’
Instead, we move to a framework-based approach: we do not pre-judge the next interest rate step, but we clearly and publicly communicate our reaction function. Markets must study our observed indicators and logic, rather than waiting for the central bank to outline a certain path.
Our decision anchors remain fixed on four elements: inflation outlook, underlying core inflation, high-frequency economic and financial data, and the efficiency of monetary policy transmission. All interest rate moves will be based on these four data categories, with no prior commitments made."
Since the comprehensive adoption of forward guidance in 2008, the policy uncertainty premium has decreased, and financial market volatility has trended significantly downward. With the removal of forward guidance, Wall Street will no longer be able to unify their rate expectations based on dot plots, meeting minutes, or officials' speeches; the importance of data such as CPI, Nonfarm Payrolls, etc. will rise significantly.
2. Bank of Japan stands ready to intervene
USDJPY broke above 162, hitting the highest level since December 1986. Despite breaking a critical level, Japanese authorities have not increased their verbal intervention efforts significantly. However, Reuters reported on July 2, citing sources, that should FX intervention be carried out in the future, Japanese authorities might no longer provide a strong pre-warning signal like on April 30.
Japan's intervention strategy has been adjusted, and may now take the form of stealthy, frequent, smaller-sized interventions executed in batches over days. With the current crowded yen short positions, interventions that could materialize at any time stand to trigger pulse-like volatility in the FX market, driving short-term breakouts in volatility in non-dollar currencies and cross rates, serving as important catalysts to break the existing low-volatility regime.
3. AI semiconductor pullback could trigger a rise in financial market volatility
The core narrative of surging AI compute infrastructure capex is starting to wobble, and the market is beginning to harbor serious doubts about the sustainability of tech firms’ capex. Meta opening up idle compute capacity for external rental serves as a turning point signal in the supply-demand structure for computing power. This, combined with concentrated chip production capacity releases globally, has led the market to price in future risks of overcapacity ahead of time.
4. Seasonal uptick in FX volatility in August
Generally, FX market volatility tends to rise seasonally in August. This may be due to diminished liquidity as US and European institutions go on summer vacation, amplifying price shocks. In addition, the Jackson Hole Global Central Bank Symposium takes place at the end of August. Without forward guidance, central bank remarks have high uncertainty, escalating market policy expectation battles and further pushing up volatility premia.
Chart: Seasonality of G7 volatility index
Summary:
This year, FX trading has been challenging. Rate market volatility has not transmitted to currency markets, and the ranges in currency pairs have remained very narrow. Looking ahead to the second half, four factors—restructuring of central bank policy frameworks, yen intervention risk, shifts in the AI industry cycle, and August’s seasonal volatility—may finally break the persistent low-volatility regime. At this stage, where trading direction is unclear, it may be worth considering volatility-long trading strategies.
Disclaimer: The content of this article solely reflects the author's opinion and does not represent the platform in any capacity. This article is not intended to serve as a reference for making investment decisions.
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