* Months of calm in markets may be about to end
* Expected monetary policy shifts to create volatility
* Investors bet on further weakness in the euro
By Anirban Nag
LONDON, Aug 27 Months of dead calm in financial
markets that have crushed trading volumes and hit bank profits
may be drawing to a close as currency investors gear up for
volatility triggered by monetary policy shifts in major
Occasional convulsions due to war and other political risks
notwithstanding, the volatility on which traders thrive and make
money has all but evaporated this year.
Bond yields have fallen steadily, stocks have traded near
multi-year highs all year and, in the $5-trillion-a-day foreign
exchange market, the most active currencies have been stuck in
But that may be about to change.
The dollar's rise to a 13-month high against a basket of
currencies has driven the euro to a near one-year low, prompting
some investors to seek protection against future swings in the
currency pair. Investors who have long predicted a strengthening
dollar wonder whether it may finally be happening.
The new trend reflects the fact that the U.S. Federal
Reserve is edging towards higher interest rates while the
European Central Bank (ECB) is set to loosen policy.
ECB chief Mario Draghi last week flagged the chances of more
action, triggering speculation that the bank is veering towards
asset purchases, or quantitative easing, to ward off the threat
of deflation. In these circumstances, analysts say, the euro and
the dollar could see sharp moves.
"The abnormal low volatility regime that we saw this summer
is coming to an end. The divergence of monetary policy between
the Fed and the ECB is behind this, but for a move higher, the
catalyst we probably need is a sharp rise in short-term U.S.
rates," said Peter Kinsella, currency strategist at Commerzbank.
The dollar index hit a high this week, gaining
momentum after Fed minutes showed policymakers debating whether
rates should be raised earlier or not.
Fed Chair Janet Yellen acknowledged those concerns last week,
while stressing the need to move cautiously on raising rates. As
a result, yields on two-year Treasuries rose more
than 8 basis points, their biggest weekly gain since June last
Reflecting some of that anxiety, one-month implied future
volatility for euro/dollar hit 5.8 percent on
Wednesday, its highest since early June and up from near record
lows of around 4.2 percent struck early in August.
One-month implied volatility for dollar/yen
has also risen to around 6 percent, from around 4.4 percent,
also a record low, struck in late July.
"Most participants have become overly comfortable with the
low interest rate environment and (they) should now revisit
their risk management strategies," said Illimar Mattus, CFO at
Armada Markets, a currency and precious metals trading firm.
"Changes in the interest rate outlook, and ultimately the
rise of interest rates, should bring an end to the
low-volatility environment and introduce higher risk to the
BEARISH EURO BETS
With short-term interest rate differentials
moving in the dollar's favour, the euro hit a near
one-year low of $1.31525 on Wednesday while the yen
languished near seven-month lows.
But the euro's losses, of 1.5 percent this month, have
garnered more attention. Investors are looking to bet on further
weakness by buying put options to sell the euro at lower levels.
Traders said there had been steady demand for euro puts, or
options betting on more weakness in the single currency against
the dollar. Options betting the euro will drop to $1.31 on Sept.
5 - the day after the ECB's next policy decision and on which
U.S. jobs data is released - have been put in place, they said.
Investors are awaiting euro zone inflation data on Friday.
Analysts polled by Reuters expect annual price increases to have
slowed to 0.3 percent in August from 0.4 percent in July. That
would be well below the ECB's declared danger zone of 1 percent
and its target of just under 2 percent.
Kinsella said euro/dollar risk reversals, a
gauge of demand for options betting on a currency rising or
falling, are likely to show more bias for dollar strength in
coming weeks as the euro's weakness gathers pace.
"The market certainly feels nervous of further volatility in
the euro from here, and it feels like some demand may be
switching back for euro puts again," said an options trader at a
North American bank.
(Editing by Susan Fenton)