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The recent fluctuations in foreign exchange (FX) volatility and the demand for the U.S. dollar, which contributed to a significant increase in implied option premiums on Tuesday, have since moderated. Despite a slight pullback in the dollar observed on Wednesday, implied volatility remains higher than usual. This elevated volatility signals a continued cautious sentiment among investors as they anticipate critical upcoming U.S. economic data releases.
Among these data points, Friday's U.S. jobs report for August is particularly notable, serving as a pivotal factor influencing market volatility. Market participants appear to be anticipating a disappointing jobs report, which could bolster expectations for a Federal Reserve interest rate cut and potentially put downward pressure on the dollar. However, the substantial gains in the dollar observed on Tuesday illustrate the inherent vulnerabilities of short positions in the currency. A surprising positive result in the jobs data could lead to a rapid unwinding or 'squeeze' of these positions.
In the context of the British pound (GBP), the implied volatility of GBP/USD options experienced marked increases on Tuesday. This rise is largely attributed to concerns surrounding the UK's fiscal situation, particularly evident in the rising yields of long-term government bonds, known as gilts. Traders demonstrated heightened demand for GBP put options, especially for those expiring in late November and December, likely intended to hedge against potential adverse market reactions following the announcement of the UK budget, scheduled for November 26. Additionally, risk-reversal options have shown an increase in premiums for downside strikes over upside ones for GBP/USD, reaching new highs not seen since March.
Specifically, the implied volatility for GBP/USD with a one-month expiry surged to 8.0 from the previous 7.2 on Tuesday, marking the highest level observed since mid-July. For other currency pairs, the one-month implied volatility for EUR/USD reached a three-week high of 7.9, while USD/JPY also registered an increase to new four-week highs at 10.05.
Looking towards the Asian markets, the option markets for USD/CNH (U.S. dollar versus Chinese yuan offshore) have exhibited a trend where implied volatility is gradually retreating towards long-term lows. This movement reflects a general outlook of subdued realized volatility. Even though front-end risk reversals still indicate a small premium favoring downside strikes, this skew is beginning to diminish, suggesting a potential shift in market sentiment.
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Patrick has been involved in the financial markets for well over a decade as a self-educated professional trader and money manager. Flitting between the roles of market commentator, analyst and mentor, Patrick has improved the technical skills and psychological stance of literally hundreds of traders – coaching them to become savvy market operators!