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Low Rate Environment Creating Boring FX Market

by on June 27, 2014 8:03 pm BST
 

The largest central banks have conducted experimental monetary policy in the wake of the financial crisis and the slower than expected rebound in economic growth. In part, the ultra-low interest rate environment conducted by central banks to try to stimulate growth, but it is creating a boring forex market.

Various forex volatility gauges have hit multi-year lows in 2014. The low interest rate environment is causing a significant dip in volume and volatility, two very important aspects to trading. Interest rates are important in the foreign exchange market because policy divergences provide trading opportunities. The low volatility is causing traders to focus on high probability carry trades while searching for yield. For instance, the Reserve Bank of New Zealand began tightening monetary policy on upbeat economic data, and the NZD has been a successful trade against popular currencies where central banks implement low interest rates (USD, JPY, EUR).

Traders are keen on central bank guidance and policy when looking for an edge when determining a potential pair’s direction. The Federal Reserve’s need to leave interest rates near-zero for an indefinite period of time has caused short-term rates to drop quicker than longer-term rates (yield curve steepening), the price action in the dollar will likely keep volatility at a minimum. Sooner or later, central banks will be forced to increase rates more sharply to account for a half-decade of ultra-low interest rate policy and volatility will quickly pickup.