Volatility Touches Its Yearly Lows as Uncertainty Rises

Volatility, which is regarded as forex trader’s best friend, in the British pound fell to its lowest levels since January 2018. Expectations for volatility plummeted to their lowest levels in more than a year as no significant Brexit-related developments were expected this week, extending a recent decline. Similar lows were seen in three and six-month measures. This drop came amid an agreement reached between the European Union leaders and the British government last week, regarding the extension of Brexit deadline, which was delayed for six months.

Volatility in currency is used to refer to the variation in a trading price of a certain currency pair exchange rate over time, which, in general, refers to the degree of unpredictable change over time. The gauge indicates the degree of risk faced by someone with exposure to that currency pair and is often viewed as a negative in that it represents uncertainty and risk. However, higher volatility normally makes Forex trading more attractive to the short-term investors and, importantly, does not imply the direction of movement. A currency market by lower volatility changes in value at a steady pace and does not fluctuate dramatically.

The pound struggled to find direction as the immediate risks around Brexit were pushed back after the extension removed the immediate threat of a no-deal exit for Britain, leaving the likelihood of months of political uncertainty in the United Kingdom. Traders said the extension provided some support to the pound but were unsure of immediate drivers for the pound and, hence, were reluctant to bet big.

A big movement in the currency was not seen despite robust jobs data: total earnings increased by an annual growth rate of 3.5 per cent in the three months to February. The data by the Office for National Statistics showed that it was the joint highest rate since mid-2008. Although better than expected jobs numbers are good for the currency, the pound fell on the back of less compromising stance signalled by a senior German minister. This divergence can be attributed to the lack of traders’ attention towards economic data as politics remains the key focus. Also, the numbers largely met the expectations and no big surprise was seen. It must be noted that tight labour market is not expected to hike in interest rate, which could have given impetus to Sterling, as Brexit uncertainty makes it hard for the central bank to have a positive outlook.

Investors had hedged their sterling positions amid the looming deadline but after the extension, they unwind those bets. Moreover, due to uncertainties, investors are broadly staying away from the pound and only taking positions to hedge overall portfolio risks. Investor surveys have highlighted the impact of uncertainties; according to a recent survey, the UK was the least favoured region among global money managers.

Volatility Index Chart

(Source: Thomson Reuters)

On 16th April 2019, at the time of writing, the volatility index was at 5.53. The downward movement started on 4th April. The index declined by 35.12% and reached to its lowest point on 11th April, when the extension was agreed. According to the analysts, spreads increase during low volatility, increasing the costs of making a trade. Moreover, sterling is expected to decline over the next few months as a battle for Conservative party leadership might result in a Eurosceptic prime minister.

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