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US Dollar: Volatility shifts with changing Fed communication – Commerzbank

Source Fxstreet

Commerzbank’s Michael Pfister argues that enhanced Federal Reserve communication has lowered average implied volatility in the US Dollar but concentrated it on FOMC meeting days. Drawing on 30 years of data across Greenspan, Bernanke, Yellen and Powell, he links longer statements and dot plots to stronger FX reactions, and warns that shorter statements could redistribute volatility across the rest of the year.

Fed guidance reshapes Dollar volatility profile

"This relationship has continued under both Yellen and Powell: the longer the statement, the more pronounced the foreign exchange market's reaction appears to be. 100 additional words result on average in a 0.14% increase in volatility on the day of the FOMC decision compared with the ten trading days prior, although there is significant variation in this relationship from year to year."

"Average volatility has fallen. Fed meetings have simply become more important for the foreign exchange markets than they were under Greenspan. This is most clearly evident from the fact that, under Greenspan, meeting days were essentially as volatile as any other trading day of the year."

"With the introduction of the dot plots in particular, it is clear that volatility is now much more concentrated on meeting days. The Fed’s improved communication has therefore reduced average implied volatility. Meeting days themselves have become significantly more volatile, while the rest of the time is simply less exciting."

"If Kevin Warsh is seeking a return to the shorter statements of earlier times, the Greenspan era suggests that meetings will be less exciting for market participants. In return, however, the remaining days of the year will become significantly more volatile. In other words, whilst the overall average volatility may have been declining for several years, it is not the level that has changed, but the distribution."

"Warsh therefore may not get what he is hoping for: volatility will not disappear, but simply become more evenly distributed across the trading days of the year. While this could be advantageous for short-term positioning around the FOMC meeting, it could also increase the need for hedging on the remaining trading days of the year."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor.)

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