Currency Markets Jolted After Months of Calm
Volatility Rises as Investors Focus on Interest-Rate Divergence
By ANJANI TRIVEDI and IRA IOSEBASHVILI WSJ
After months of calm, currency markets have sprung back to life, as investors scramble to take advantage of the divergent paths taken by major central banks.
Bigger and more-frequent shifts in the foreign-exchange market are a welcome relief for investors, many of whom struggled to make profitable trades when currencies weren’t moving as dramatically.
Banks, whose currency desks execute trades on behalf of clients and companies, also see revenues grow when choppier markets drive up demand for their services.
“This definitely brightens my day,” said Chris Stanton, who oversees about $200 million at California-based Sunrise Capital Partners LLC. “It’s a welcome return to what feels like a freer market.”
- U.K. Pound Hits 10-Month Low on Scotland Fears
- Emerging-Market Currencies Slide
- Swiss Franc Falls vs. Euro
The size of daily trading swings across currencies has jumped 55% since hitting its lowest in at least a decade on July 31, according to Deutsche Bank AG. During that time, the dollar climbed to a six-year high against the yen, the euro fell below $1.30 for the first time since July 2013 and the pound tumbled to a 10-month low against the dollar. On Wednesday, the Swiss franc saw its biggest drop against the euro in six months.
Driving the price swings is a shift in policies at some of the world’s largest central banks. A burgeoning recovery in the U.S. has brought the Federal Reserve closer to raising rates, a move that would make the dollar more attractive to investors. At the same time, European and Japanese central banks are still trying to kickstart their economies and relying on policies such as bond buying that tend to drive down interest rates and reduce the value of a currency.
Implied volatility, which tracks the price of options used to protect against swings in exchange rates, has surged 45% in September to an eight-month high, according to Deutsche Bank. Higher implied volatility suggests money managers are buying options in anticipation of a more-active market.
Some money managers are buying the dollar ahead of next week’s Fed meeting, where policy makers could send firmer signals on their outlook for interest rates. Mr. Stanton’s fund is betting that the dollar will continue to strengthen against the yen and emerging-market currencies as the Fed gets closer to raising interest rates.
Citigroup Inc., C +1.11% the world’s largest currencies-dealing bank, on Monday said its markets revenue, which includes currency trading, is on track to be roughly flat in the third quarter compared with the same period in 2013, ending a decline that started a year ago.
Until recently, unusually calm markets had left investors with fewer opportunities to trade and led to the demise of several large currency funds. FX Concepts LLC, founded in 1981 and considered a pioneer in currency investing, closed its doors last year after assets shriveled to $660 million from $14 billion before the financial crisis.
Currency volatility plummeted after the financial crisis, as the world’s biggest central banks cut interest rates to near zero. That gave traders little incentive to try and capture the difference in interest rates between various currencies, a key driver of activity in the foreign-exchange market.
That status quo has started to crack. Minutes from the Fed’s July meeting showed growing support for raising rates, spurring gains in the dollar when they were released in August. Earlier this month, the ECB surprised investors with a rate cut, bringing down the euro. Meantime, the pound tumbled on concerns over the repercussions from Scotland’s possible secession. On Wednesday, the Swiss National Bank said that it could introduce negative interest rates to halt the franc’s rise.
Trading bands of some major currencies have widened this summer, opening the door to bigger profits for investors. So far in September, the dollar is moving on average by 0.70 yen a day, the biggest range since February and up from 0.35 in July. Daily moves in the euro this month are averaging 0.79 U.S. cent, compared with 0.4 cent in July.
“Now, there are more opportunities to make money,” said Masafumi Takada, vice president of currency trading at BNP Paribas SA BNP.FR -0.39% in New York. Business volume at the bank’s New York currency-trading desk has quadrupled since July, Mr. Takada said.
Currency volatility can be a double-edged sword. Investors can profit by riding the dollar’s steady move higher against a variety of currencies. But a sudden reversal—such as a surge in the pound if Scotland votes against independence—could catch traders off guard. Goldman Sachs Group Inc. GS +1.39% took a loss on an options trade involving the dollar and yen about a year ago, people familiar with the matter said. Last summer, the yen’s months-long decline had stalled.
Federal Reserve Chairwoman Janet Yellen attends a Board of Governors meeting at the Federal Reserve in Washington last week. Associated Press
Some traders believe the current bout of volatility may die down. The large moves seen this week are unusual, analysts say.
On Wednesday, the euro fell 0.2% to $1.2917, while the dollar rose 0.6% against the yen to 106.85. The pound rebounded, with the dollar falling 0.64% against the British currency.
Still, many find it hard to imagine that the magnitude of the Fed’s policy shift won’t continue sending waves across currency markets.
“The dollar’s on a tear, and there is more of this to come,” said Kit Juckes, a strategist at Société Générale SA.
—Justin Baer and Saabira Chaudhuri contributed to this article.