After the volatility spike seen in 2020, the Forex market is once again in the rearview mirror. Multiple factors led to suppression in volatility and it acted as a self-reinforcing cycle, reducing the appetite of both retail and institutional traders. However, there are still people looking after trading opportunities, even if that means trading exotic pairs, which is why we want to talk about what led to the rapid shift for a low-volatility environment.
#1 Attention still on stocks and crypto
If we scan over the main financial headlines in the media, a lot of talking about stocks or crypto. That happens because daily returns are much larger as compared to FX, which leads to more flows towards those markets. Retail traders are in constant search for volatility since that’s the only way they can make any profits.
Only a few handfuls will choose to work in a low-volatility environment, mainly due to their trading strategy. When or why the attention could shift towards FX again is still unknown, so in the meantime, the current leading asset classes might continue to be in the spotlight.
#2 Fiscal and monetary interventions
Central banks and governments intervened aggressively since March 2020 to counteract the pandemic-induced economic downturn. They’ve flushed the markets with liquidity and it leads to a suppression of FX volatility. This shouldn’t be a surprise considering the exact same thing happened after the 2008 financial crisis.
We need to be aware that the FX market accounts for over $5 trillion in daily volumes and high liquidity generally correlates with low volatility. However, central banks and fiscal authorities are well-known for making mistakes, meaning down the road there might be occasions where they lose control over volatility once again.
#3 No new major catalyzers
A Brexit deal had been reached, US Presidential and Senate elections are over, as well as other major economic risks. The financial markets are focused now on the reflation phase, which could lead to some challenges down the road. In the absence of new major catalyzers, the FX market should react to higher inflation expectations and interest rates.
The US dollar is already showing signs of bottoming, leading to weakness in the Euro and a retracement of the overall risk sentiment. Although we don’t expect FX volatility to pick up as it did last year, we expect to see numerous solid trading opportunities, especially once the summer kicks in.