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10/22/2018 0 Comments

Currency volatility and the current markets

The Euro came off its lows after the news that Italy wanted to start discussions over their budget with the European Commission. While coming off the recent lows, many market participants are not sure this will be the end of the volatility in the Euro or any other currency in the near term. Taking a look at the bigger picture we can see that, while the headline news certainly does affect there markets, the increase in volatility is nothing new. 

Since the start of the crisis, major central banks lowered their interest rates to historic lows to stem the crisis and stimulate the economy. After the initial shock of the market turmoil this brought volatility down since interest rate differentials were the only measures to use and no country looked ready to start a rate increase cycle any time soon (The ECB tried it to their detriment). With the announcement of QE across central banks, volatility increased as the balance sheets of the major central banks started to swell. 
Picture
Source: CBOE
Now we are starting to see the volatility decrease as the US starts to shrink its balance sheet. Europe is expected to follow suit with the end of their QE program this year and the start of higher rates in the middle of 2019. Barring the current threats of Italy the removal of the ECB in open market operations will bring down the volatility of the Euro. At that point we will be back to pricing the Euro based on interest rate differentials and this is where the importance of the Eurozone unity will come in. The level at which the euro is set will be dependent on several interest rates as opposed to just the ECB rate. It will be at this time the that spreads concerning the markets today will truly have an impact on the currency.
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