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Ebb and Flow of Financial Signals Increase Foreign Exchange Volatility

Volatility has migrated to the foreign exchange markets, especially the dollar/yen exchange rate. After a significant rally in early February, equity and interest rate volatility have subsided -- along with a slide in interest rates and despite oil-driven fluctuations in equity values. This shift is highlighted by rescaling indexes to 100 as of the start of 2016 (Figure 1).

Possible factors driving the increase in foreign exchange volatility are the (perverse) reaction of the yen exchange rate after the Bank of Japan’s decision to turn interest rates negative, the possibility that the UK might decide to exit the EU (known as the British exit, or Brexit), as well as uncertainty regarding what central banks will continue to apply stimulus measures, and to what degree. The probability of another hike by the U.S. Federal Reserve is lower but still positive. On the other hand, the European Central Bank and the Bank of Japan are talking stimulus.

Figure 1. TYVIX, VIX, BPVIX, JYVIX, EUVIX indexes rescaled to 100 as of the start of 2016


Figure 2. Statistical update


Forward Outlook

The recent drop in the CBOE VIX Index has flipped its term structure of forward prices to contango. TYVIX is expected to decrease in the short run, then recover. The term structures of FX VIX Indicators exhibit twists and turns that could reflect current insecurity by market participants.

Figure 3. Term structures of VIX-like volatility indexes