Trader Complacency on Display in Currencies’ Relative Volatility

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Emerging-market currencies have become a relative sea of calm amid Greece’s debt crisis and China’s collapsing stock prices, marking a level of complacency that strategists say is destined to end badly.

JPMorgan Chase & Co. indexes show volatility in the exchange rates of developing economies fell below price swings for the Group-of-Seven currencies last week by the most since 2013. It’s usually the other way around in turbulent times.

Investors may be underestimating the one thing that may upend riskier assets: the will of the Federal Reserve to raise interest rates at least once before the year is out. Janet Yellen, chair of the U.S. central bank, said Friday that while events such as Greece added uncertainty to the economic outlook, she still expected it would be “appropriate” to boost the federal funds rate by year-end.

“What’s the single most important thing which can really hurt emerging markets?” said Geoffrey Yu, a senior currency strategist at UBS Group AG in London. “It’s the rise in U.S. real rates.”

JPMorgan’s index of volatility for emerging markets -- a group whose membership includes nations ranging from Brazil to Poland and Malaysia -- climbed to 9.4 percent on July 8. That was 1.4 percentage points below the 10.8 percent level for G-7 currencies.

China Rebound

By Monday, that difference had narrowed to 0.8 percentage point after Yellen’s remarks, a rebound in Chinese stocks and news that Greek Prime Minister Alexis Tsipras had secured a deal on his country’s bailout.

While China is designated an emerging market, the rout that wiped $3.9 trillion from its stock markets in less than a month and a slump in economic activity to a six-year low fueled speculation that its demand for raw materials would diminish. That hurt the currencies of commodity exporters such as Australia, New Zealand and Canada.

Price swings in other Asian currencies, by contrast, have been relatively contained, even as an index measuring their value approaches a five-year low. Of the six emerging-market exchange rates with the biggest declines in implied three-month volatility this year, all but one are Asian.

Asia Insulated

“The main issue is, all of the events that are going on right now, markets aren’t drawing a link in terms of how they can see this really affecting Asia,” UBS’s Yu said.

History suggests that volatility is unlikely to remain low once the U.S. announces when it will start tightening policy. When the Fed said it was considering tapering its record bond-buying program in 2013, the Indian rupee and Turkish lira tumbled to all-time lows, while swings in their exchange rates jumped to the highest in at least 1 1/2 years.

India’s current-account deficit “has narrowed a lot since we had the taper tantrum in 2013,” said Chris Turner, head of currency strategy at ING Groep NV in London. “But I’d still think, if equities come off and set the tone for the third quarter, the rupee would be pretty vulnerable.”

Large Reserves

The decline in volatility and emerging nations’ near-record $7.5 trillion in foreign reserves haven’t protected traders from big losses.

An index of 20 developing-nation exchange rates has fallen more than 4 percent since mid-May. Strategists surveyed by Bloomberg predict that all but five of the 24 leading emerging currencies will weaken through the middle of next year.

Speculation is growing that Yellen and her colleagues will raise U.S. interest rates before 2015 is out, though probably in December rather than earlier in the year.

“The Fed raising rates as soon as September is somewhat moving to the sidelines for now,” said Derek Halpenny, the London-based head of European markets research at Bank of Tokyo-Mitsubishi UFJ Ltd. “Emerging currencies might be getting some comfort from that, but to be honest I wouldn’t expect that to be sustained.”

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