Currency traders are now firmly convinced that Donald Trump's policy initiatives are set to ignite volatility within the massive $7.5 trillion-a-day foreign exchange market. After a prolonged period of relatively stable movements, a key gauge of one-year volatility on the euro-dollar exchange rate witnessed a significant surge following the election. Hedge funds have been actively scooping up options contracts that offer payouts in case currency swings intensify, and strategists have made substantial revisions to their currency forecasts.
Uncertainty and Policy Implementation
While it remains uncertain precisely how swiftly Trump will enact policies such as trade tariffs that could inflict substantial pain on currencies like the euro, investors are highly certain that unpredictability will be a prominent characteristic of his tenure. There is also the enigmatic factor of how different countries will react to Trump's measures and the subsequent impact those countermeasures will have on global markets. Julian Weiss, the head of G-10 vanilla FX options at Bank of America, pointed out, "It's an environment where FX becomes particularly interesting. Demand for longer-term products has seen a notable pickup. Any hedge fund across the globe, regardless of their initial equity focus, is now seeing an increased emphasis on FX exposure."The Shift from Central Bank Calm
This trend represents a remarkable turnaround from the past few years when central banks, through a series of interest rate hikes and subsequent cuts in unison, ushered in a phase of extreme tranquility. Now, with Trump's America First policies anticipated to fuel inflation at home, traders anticipate a widening policy gap between the Federal Reserve and other major central banks. This is expected to break major currency pairs, such as the euro-dollar, out of their narrowest range in years. Banks have significantly lowered their forecasts for the currency pair in the wake of the US election, anticipating a slide towards parity. Dominic Bunning, the head of G-10 strategy at Nomura, stated, "We would expect Trump's likely policies to create greater room for macro-economic divergence, which would lead to more significant FX moves."Options Trading and Market Sentiment
Options traders at NatWest Group Plc have noticed that trading activity has been highly concentrated around wagers on euro, Aussie dollar, and yen movements against the dollar. Traders at UBS Group AG have also noted that placing bets on Chinese yuan weakness has become a popular trading strategy. Henry Drysdale, the co-head of currency options trading at NatWest, said, "Currencies with the greatest perceived exposure to tariffs and Trump's policies will continue to be favored from a volatility perspective." Market projections for a stronger dollar under Trump also contribute to the elevated hedging costs as the correlation between the US dollar and volatility reaches its peak when the greenback is in high demand.Risks and Uncertainties Ahead
Of course, there is a risk that a significant portion of the expected turbulence gets factored into market pricing in the lead-up to Trump's inauguration, resulting in longer-term swings that are softer than anticipated. This was a common occurrence during Trump's previous presidency, partly because policies like trade tariffs took longer to implement than expected. This time around, the Republican control of the House and the Senate may lead to more rapid and forceful policy implementation. Additionally, there is the unpredictable element of daily currency movements in response to the president's regular Tweets, a situation that traders vividly recall from his previous term. Shahab Jalinoos, the global head of currency research at UBS, warned, "2025 will be a year of volatility and uncertainty. We don't yet know what will transpire under Trump, and there are numerous crosscurrents at play."