COMMENT-Data and Central Banks may fail to spark FX Volatility

Option premiums suggest that upcoming U.S. economic data and central bank policy announcements may not significantly revive FX market volatility.

Implied volatility, a crucial predictor replacing the unknown real-time FX volatility in option pricing, offers a trading edge when it diverges from actual market volatility. Despite key U.S. retail sales and PPI data being factored into overnight options, their implied volatility remains notably low, indicating minimal expected market movement. For example, an overnight EUR/USD straddle option with a 6.0 implied volatility points to a mere 24 USD pips movement in either direction.

The anticipation surrounding the Bank of Japan's policy announcement did initially raise 1-week expiry USD/JPY option implied volatility from 9.0 to 13.0 after including the announcement and any potential policy changes. However, this volatility has since decreased to 11.5 amid a broader trend of diminishing implied volatility following the recent U.S. CPI data release.

One-week expiry options now include interest rate policy decisions from the U.S., UK and Switzerland, but a limited increase in related implied volatility hints at muted market expectations for a significant uptick in FX realised volatility.

EUR/USD is one of the most liquid and highly traded currency pairs and its implied volatility can provide a bellwether for the broader FX outlook. The benchmark 1-month expiry implied volatility trades at its lowest levels since November 2021 at 5.0, yet still appears rich when compared with past realised volatility measures.