Commerzbank’s Volkmar Baur has observed that the realized 3-month volatility of the EUR/USD exchange rate has dropped to 4.53%, marking a near five-year low. According to Baur, this level of volatility has only been lower on 2.2% of trading days since May 31, 2007, based on Bloomberg data, and only three instances in the past nearly 20 years have seen lower realized volatility for EUR/USD [1].
Baur attributes part of this calm to highly correlated central bank rate expectations, which are influenced in part by oil prices. However, he notes that this factor alone does not fully explain the current subdued volatility. A comparison with other G10 currencies reveals that lower exchange rate volatility against the euro is generally observed where central bank expectations this year are more correlated than last year [1].
Despite the low realized volatility, implied volatility for EUR/USD now stands more than one percentage point above historical volatility. This divergence is unusual, as historical and implied volatility typically move in tandem, with 80% of implied volatility movements explained by historical volatility over the past 20 years. The current gap between the two volatility indicators has been greater on only about 4% of trading days in the same period, suggesting that the market expects EUR/USD volatility to rise soon [1].
Baur concludes that while oil prices and central bank expectations have contributed to the low volatility, there are additional factors at play. The significant divergence between implied and realized volatility indicates that market participants are anticipating increased volatility in the EUR/USD exchange rate in the near future [1].
CONCLUSION
The unusually low realized volatility in EUR/USD, coupled with a notable rise in implied volatility, points to market expectations of increased swings ahead. While central bank rate correlations and oil prices have contributed to the calm, the divergence suggests traders are preparing for heightened volatility. Investors should monitor EUR/USD closely for potential market-moving developments.