We have not been short of important economic and political news this year. As a result, readings of economic uncertainty remain historically high even if below the peaks earlier in the year when the US Administration’s tariff tantrum was in full swing. But implied 1-month volatility amongst the G10 currencies is around 7.5%, which is close to the lowest we have seen in over a year. And it is not just developed currencies. One-month implied volatility in dollar/rand is the lowest we have seen in over a decade.

So, why the disconnect between uncertainty and volatility? Steven Barrow, Head of Standard Bank G10 Strategy, argued that maybe this should not be so surprising after all. For high uncertainty sends traders and investors into their shells as they don’t have any clarity on where currencies might go. But beyond this, the changing nature of the currency market may be leading to periods of low volatility.

“We have also spoken before about the nature of these changes. Of how the FX market has become increasingly dominated by non-bank financial institutions relative to other players such as interbank dealers, non-financial institutions and more. And how the FX swap market has outpaced growth in other segments of the market, notably spot FX. If we put these things together, we sense that the FX market has evolved from a short-term speculative market into one where FX is used primarily to fund longer-term asset positions of these non-bank financial institutions. If this is correct, it suggests that FX rates don’t move as much because of short-term speculative behavior but, instead jump when shocks occur that force non-bank investors to adjust positions. The sort of shocks we are thinking about here include the tariff tantrum earlier in the year’s, last year’s surprise BoJ rate hike, the Russian invasion of Ukraine in 2022 and more”, said Steven Barrow.

In short, what happens is that, when these big shocks shift asset prices, the FX market adjusts as investors do two things. The first is they adjust their FX funding, perhaps by increasing or reducing currency hedges. The second is a slightly longer-term effect at these same investors gradually change their underlying asset positions to account for the likely effects of the economic or political shock. The market tends to be increasingly governed by big volatility spikes, when shocks occur but, in between times, volatility falls and currencies tend to flat-line.

If we were to go back to the 1990s for instance, the release of monthly trade data in the US would regularly and instantaneously move the dollar by huge amounts, often four or five big figures in terms of dollar/deutschmark, which is equivalent to around two big figures in euro/dollar in today’s money. But today we hardly see any reaction at all to trade numbers, and even other data that moves the US dollar more, like payrolls, does not bring this magnitude of instantaneous reaction. It shows that FX markets in the 1990s – and before—were more of a ‘speculative market,’ dominated by interbank trading. But not anymore, and this means that when there are no big shocks to force non-bank financial institutions to adjust their hedges or asset positions, the FX market just idles as the dearth of speculation, relative to the past, isn’t sufficient to create any significant directional trends, or at least not in the major traded currency – the US dollar.

The development of cryptocurrency may also have a role to play as hardy speculators are drawn to this, highly volatile, market and away from the drudgery of the euro/dollar and other major currencies. So, what’s the lesson for those that use the FX market for whatever reason? In Steven Barrow’s view, it seems to be that you should assume major currencies won’t move very far until really significant economic or political shocks occur. Of course, determining whether a shock is big enough to evoke a major change in currency trends is another matter.