Before the release of the U.S. August non-farm payrolls, currency hedging costs rise as traders prepare for increased volatility in the foreign exchange market
After experiencing a calm summer, the hedging costs in the currency market have risen again, as traders position themselves for potential price fluctuations triggered by the upcoming U.S. employment report. The one-day implied volatility of the euro against the dollar has risen to its highest level since June, reflecting the significance of the non-farm payroll data. If the employment data is weak, it may fuel market bets on a Federal Reserve interest rate cut, pushing the dollar lower. At the same time, the hedging demand for the pound is also increasing, with the relative hedging costs for three-month terms reaching their highest level since January
According to Zhitong Finance APP, after experiencing a calm summer, the hedging costs in the currency market have risen again, as traders are positioning themselves ahead of the potential for greater price volatility triggered by the U.S. employment report set to be released on Friday.
On Thursday, the one-day implied volatility of the euro against the dollar rose to its highest level since June and is expected to record the strongest closing level since April. This spike in volatility reflects the importance of the non-farm payroll data—traders need it to gauge the Federal Reserve's next move. In a speech last month, Federal Reserve Chairman Jerome Powell stated that "the downside risks to employment are rising." Meanwhile, data released on Wednesday showed that U.S. job openings fell to a 10-month low in July, making Friday's non-farm payroll report even more significant. If the employment data released on Friday is weak, it could fuel market bets on a larger rate cut by the Federal Reserve, thereby pushing the dollar lower.
Elias Haddad, a strategist at Brown Brothers Harriman, stated, "The August non-farm payroll report will determine whether the market begins to price in expectations of a 50 basis point rate cut by the Federal Reserve on September 17, while the current market pricing only reflects a 25 basis point cut."
The British pound is also attracting hedging demand. The relative hedging costs for three-month terms have risen to their highest level since January, as traders prepare for potential market volatility surrounding the budget announcement by UK Chancellor of the Exchequer, Jeremy Hunt, on November 26. George Saravelos, an analyst at Deutsche Bank, noted that global concerns over fiscal policy are creating a "perfect storm," driving up yields and dragging the pound lower.
Non-farm payroll data is not the only driving factor. This week, the index measuring the overall expected volatility of G10 currencies has risen to a one-month high. Risk factors are piling up, from fiscal concerns in the UK and political turmoil in France to geopolitical tensions, a series of central bank meetings, and worries about the independence of the Federal Reserve.
On Thursday, the weekly volatility of the euro reached a two-month high, covering the upcoming European Central Bank meeting and U.S. August CPI data. Although the market generally expects the European Central Bank not to adjust its policy at next week's meeting, previous statements from policymakers have opened the door for interest rate hikes, making forward guidance crucial. The U.S. August CPI data, along with Friday's non-farm payroll report, may set the tone for the Federal Reserve's policy meeting this month.
