Mixture

Bloomberg reported yesterday that, by one measure, expectations for short-term volatility in the foreign-exchange market were near a two-month low:

The JPMorgan Global FX Volatility Index was at 9.60 percent after falling to a two-month low of 9.55 on Oct. 12. The measure has dropped more than a percentage point in October, set for the biggest monthly decline since February.

That trend has continued on Wednesday, as the index fell to 9.54, the lowest level since Aug. 17.

Just as the VIX Index tracks consensus expectations for near-term stock market volatility based on S&P 500 option prices, the JPMorgan index is a measure of traders' expectations for volatility on the foreign exchange, based on three-month currency option prices.

The Bloomberg journalist attributes this phenomenon to dashed expectations regarding changes in central banks' policies:

Expectations for price swings in currency markets were near a two-month low as central banks disappoint traders hoping for bold policy actions. A JPMorgan Chase & Co. gauge of global currency volatility headed for its biggest monthly decline since February as traders anticipate the Federal Reserve will delay increasing interest rates until next year.

Beyond the Fed, another major actor is the European Central Bank. Until this week, that market was increasingly counting on an expansion in the ECB's quantitative easing, but governing council member Christian Noyer appears to have put paid to that notion.

It's worth noting, however, that any measure of future volatility expectations based on options' implied volatilities, like the JPMorgan index, is largely driven by recent historical volatility in the underlying asset (the notion that the recent past is the best predictor of the near future is practically instinctive).

The following six-month graph shows the JPMorgan index (white line) versus an index of one-month historical volatility in the euro-dollar exchange rate (yellow line). Note how tightly correlated the two series are:

Fx Volatility Graph
Source: Bloomberg.

But let's not lose track of the bigger picture: In the post-financial-crisis period, central banks have acted as a massive buffer against asset price volatility.

Perhaps the near future will be less volatile, but as we transition to a world in which central banks are less involved in asset markets and interest rates are no longer stuck at the zero bound, the longer-term trend for volatility will be up, not down.

In other currency news, the Canadian loonie suffered its largest decline in three months after the Bank of Canada kept interest rates unchanged while reducing its forecast for economic growth:

 

Value/Change

Dollar Strengthening/ Weakening

EUR-USD (CURRENCY:EURUSD)

$1.1340

(0.05%)

Strengthening

USD-CAD (CAD = Canadian dollar):(CURRENCY:CADUSD)

C$1.3126

+1.12%

Strengthening

GBP-USD (GBP = British pound): (CURRENCY:GBPUSD)

$1.5423

(0.14%)

Strengthening

Source: Bloomberg. Data as of 3:27 p.m. EDT on Oct. 21.

Alex Dumortier, CFA, has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.