Photographer: Akio Kon/Bloomberg

Yen Trading More Perilous Than India's Rupee as Volatility Flips

  • Price swings for G-7 currencies higher than emerging markets
  • End of dollar rally, yen strength, Brexit confound forecasts

When traders are more worried about the yen than the Indian rupee, it’s a sign of just how crazy the currency market has become.

Implied volatility on developed-nation currencies exceeds that of emerging markets for the first time in a year. Growing doubt about central banks’ ability to induce growth and inflation in Japan and Europe and optimism that emerging nations will avoid widespread economic slowdown have upended patterns in foreign exchange.

“Investors are less confident on how the dollar is going to perform against the developed markets, but they understand the narrative you’re seeing in emerging markets,” said Paresh Upadhyaya, director of currency strategy in Boston at Pioneer Investments, which oversees about $236 billion. “All of that makes you feel a little more confident in the next three months or so emerging-market assets can continue to rally.”

Pioneer bought Brazil’s real and India’s rupee against the dollar during the past month.

Group-of-Seven currencies are generally less volatile, given the markets are bigger, the economies are more stable, and years of unconventional easing measures have kept currencies, such as the euro and the yen, weak and limited price swings. The change of fortune may fuel a further rebound in emerging-market currencies, which have gained 4 percent this year after losing 15 percent in 2015.

JPMorgan Chase & Co.’s G-7 Volatility Index surged as high as 12.4 percent this year, while its emerging-market measure dropped to as low as 10.3 percent. Options for the yen and the pound are pricing in more volatility than for the rupee and Poland’s zloty.

The bigger swings in the yen were accompanied by its 12 percent advance versus the dollar this year, which goes against the grain of negative interest rates pursued by the Bank of Japan, a policy that theoretically diminishes the currency’s appeal. The BOJ’s decision to keep rates on hold last month exacerbated confusion about the central bank’s path.

Yen Strength

“They need a weaker currency, but the BOJ did nothing even when the yen had appreciated 13 percent on the year,”’ said Arindam Sandilya, a Singapore-based currency strategist at JPMorgan Chase. “That raised a lot of eyebrows and people started asking if it was unwillingness or an inability to make the change to get a weaker yen.”

The rupee strengthened 0.8 versus the dollar during the past two months as overseas investors poured more than $1 billion into Indian stocks and bonds this quarter, while inflation stabilized and the central bank extended monetary easing.

The last time JPMorgan’s major currencies volatility index moved above that of emerging nations was in May 2015 after the dollar had started a retreat a few months earlier as prospects of Federal Reserve monetary policy tightening faded and European leaders wrangled over how again to avoid a Greek debt default.

A fragile global economy and confusion about central-bank policies have led to irregularities in other markets as well. Underneath the rally in the S&P 500 index of stocks in the past three months was a 20 percent slump in trading volume. Global bond yields are close to record lows, even as the Fed embarked on its tightening cycle.

Central Banking

Global central banks aren’t forecast to directly intervene to weaken their currencies to achieve their goals. The U.S. Treasury Department put Japan and four other economies on a currency watch list, saying their foreign-exchange practices bear close monitoring to gauge whether they provide an unfair trade advantage.

“Paradoxically, even as you aren’t getting the policy-induced moves in these currencies, it leaves the floor open for the market to push it around,” said Steven Englander, New York-based global head of G-10 currency strategy at Citigroup Inc., the world’s biggest currency trader. “People say central banks aren’t going to be there, there is not a credible threat.”

Volatility in the pound rose to a six-year high last month before a vote on Britain’s membership of the European Union on June 23, which may spark wider price swings across the region. The referendum has made sterling the developed world’s worst performer in 2016.

The halt to the dollar’s two-year appreciation trend threw some sectors of the currency market into disarray, said Greg Anderson, global head of foreign-exchange strategy in New York at Bank of Montreal. The U.S. currency’s 20 percent rally the past two years fell apart in March as a slowing economy prompted the Fed to cut growth and inflation forecasts, and set a higher bar for when it may raise rates again following a move in December.

While currency gains brought on by the weaker dollar aren’t welcomed in developed nations struggling to boost economic growth, they’re embraced by emerging-market central bankers battling capital outflows and depreciation. The outlook for emerging markets also improved after concern about China’s growth subsided, and the recovery in commodity prices increased revenue for producers such as Brazil and South Africa.

“Emerging-market central bankers are having an easy time controlling their currencies because now they have inflows,” Anderson said. “Group-of-10 central banks can’t smooth the moves so they continue to have volatile price movements.”

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