FX Daily: Low Volatility Prevails

Volatility in FX markets continues to sink as investors seem quite comfortable with the prospect of the Fed holding or tightening the policy rate in September. Expect FX carry trades to remain in demand for the time being, but eyes to stay keenly on the bond market. Here, the issue is whether investors can absorb a lot of new supply from the tech sector.

USD: Realised volatility sinks

Perhaps unsurprisingly, realised FX volatility is sinking in mid-August. The main risk event on the horizon is the Fed's policy meeting on 16 September, where the market prices exactly a 50% chance of a 25bp hike. Whether the Fed hikes or not will be determined by a few data points ahead of that meeting. However, it looks like investors are not going to be unnerved by that meeting and will, instead, be comfortable picking up carry from high-yielding FX. In G10, the Norwegian krone has delivered the strongest total returns this quarter, while in emerging markets, three Latin American currencies rank among the top four performers.

Should tomorrow's US July CPI release nudge market pricing towards or against a September Fed hike, we doubt it would have much impact on the carry trade.

The one wrinkle on the horizon is the bond market. Longer-dated US Treasury yields are at the top of recent ranges and the tech industry is planning a lot more issuance. Nvidia announced yesterday it would partner with six investment houses to arrange $500bn of debt financing for its customers. Buy now, pay later. A sell-off in the bond market probably remains one of the key threats to a benign environment over the coming months.

For today, the US data focus is on July existing home sales and the weekly ADP release. For the latter, the four-week moving average has dropped to +18k from a peak near +38k in April. Any downside surprise here could briefly hit the dollar following Friday's soft July payrolls release.

DXY looks set to continue trading in a 99.50-100.00 range into tomorrow's CPI release.

EUR: Gone fishing

EUR/USD realised volatility continues to sink and one-year is now at 5.8% – matching the low from November 2024. As above, it is hard to see that environment changing anytime soon – or at least until mid-September when central bankers around the world return from their summer breaks.

We published an article yesterday looking at the dollar hedge ratios of European investors. The risk here is that European investors in the US are once again underhedged and have to quickly raise their dollar hedge ratios should the dollar look vulnerable again. That probably looks more a function of the November midterms than Fed decisions.

It is hard to see EUR/USD trading much outside a 1.1515-1.1560 range today.

AUD: RBA holds onto hawkish bias

The Reserve Bank of Australia left rates unchanged at 4.35% today. Some argue that the added description of the policy as 'somewhat restrictive' means that the RBA is less likely to hike in future. However, Governor Sandra Bullock proved quite hawkish at the press conference, reminding the audience that the RBA sees inflation risks as skewed to the upside and admitting that the RBA did discuss the possibility of a rate hike at today's meeting. This prompted short-dated Australian yields to do a U-turn.

Our team does not see a further RBA rate hike this year, but from an FX perspective, we still see AUD/USD heading up to 0.73 by year-end.

CZK: Inflation details in focus as hike pricing supports koruna

The Czech Republic publishes the final July inflation estimate today, likely confirming the flash reading of 1.7%. The key focus will be the detailed breakdown, especially components watched closely by the Czech National Bank. Core inflation likely stayed at 2.8%, with a risk of 2.9%. The CNB will also look at what drove service price inflation up to 4.7% in July and whether imputed rents continue to show signs of slowing. Last week’s CNB meeting, however, suggested the board is comfortable with the current level of monetary tightening, leaving a high bar for another hike.

We had expected the market to price out more tightening after the CNB meeting, but global market pressure has taken over and again pushed CEE pricing toward additional hikes. The Czech market still leads EMEA, with two hikes priced in, reflecting the view that the CNB is most sensitive to renewed energy price pressure after its June hike. We do not expect those hikes to be delivered, but the pricing offers some support for FX. Having been bullish on EUR/CZK before and after the last CNB meeting, we now see the pair peaking around current levels, slightly above 24.250, with scope for some relief below that today.