Why calm currency markets are at odds with conventional wisdom

Things are quiet in currency markets. But it is not the reassuring peace. Conventional wisdom indicates that macroeconomic uncertainty should generate fluctuations in prices. Brexit is just over a month away while in Europe economic data has been diminishing as uncertainties over Italy and Spain persist. Looming European parliamentary elections at the end of May are another probable cause of political headwinds. And even though the euro has been trading in a narrow range between $1.12 and $1.18 against the greenback for over 70 trading days. Realised volatility – the measure of price moves that developed in a specific period – is now near the historic lows of 2014.

With the scarcity of reaction in currency markets is down to investors’ conviction that liquidity will remain to be ample, despite the precarious global growth backdrop. Paradoxically, it is that poor growth outlook that is allowing stock markets to rally while preserving a cap on large fluctuations in forex prices, because that subdued data are stopping central banks from “normalising” monetary policy and withdrawing liquidity from displays. The US Federal Reserve is indicating that it will not raise rates in the short term while the ECB is also again considering stimulus. The Bank of England, meanwhile, is developing into an improbable contender for tightening policy amid ongoing fears over Brexit.

Leaving FX markets in an analogous condition as during the post-crisis period when extra-low interest rate policies and stimulus measures dampened volatility coupled with the recognition that central banks will step into the breach once more and continue to provide markets with liquidity.