Flat yield curves and the prospect of unchanged G3 monetary policy into 2020 have seen volatility collapse across G3 FX pairs. Yet there’s plenty going on elsewhere with Brexit, tightening in Eastern Europe and a re-assessment of some Asian FX trends. Local stories and relative value will be in focus this month
The ECB’s decision to extend its forward guidance into year-end has smashed interest rate and FX volatility in Europe. EUR/USD implied volatility has dropped back to levels last seen in 2014. We see EUR/USD staying subdued into 2Q19 with potential to drop closer to 1.10 if, as we believe, the Fed will be in a position to hike rates in 3Q19.
But low volatility in the Eurozone masks the fireworks of Brexit. March will be make-your-mind-up time for the pound. There is a potentially bullish cocktail out there of a long delay/fiscal stimulus/rate hike, but key votes later in March will determine whether GBP can fulfil its potential. Clearer stories exist in Norway and Hungary where high inflation should prompt tighter policy and further strength in both the NOK and HUF.
Lower volatility also helps carry trades by increasing risk-adjusted returns. If, and it’s a big if, trade tensions do not flare up again and European activity can start to recover (there are early signs) then emerging markets should do well. Here we favour the high yield MXN, which should substantially outperform its forward curve. However, watch out for the high yield RUB. Current levels may be the best of the year before the current account deteriorates and the US sanctions threat re-appears this summer. A new central bank governor also poses a threat to what was the outperforming PHP.