On Tuesday, we talked about how volatility in the forex market has exploded in 2008. Although trading ranges expanded significantly in October and November, volatility has contracted since the beginning of the month.
The following chart from Bloomberg illustrates how far 3 month volatility for the EUR/USD has fallen since hitting a record high in late October. Anyone that follows the currency market on a regular basis can attest to its recent range trading behavior. There are good reasons for the compression in volatility as the year is winding is coming to a close and new positioning becomes one of the last things on the minds of currency traders. It has been a tough year and many funds are closing their books early to lock in remaining profits.
If volatility does continue to fall, it would help carry trades recover. One of the big reasons why the Japanese Yen has outperformed this year is the explosion in volatility.
However it may still be premature to say that volatility in the currency market has peaked because December 16th will be a historic moment for the US Federal Reserve. Not only are they expected to take interest rates to the lowest level this generation has ever seen but they have to figure out how to effectively signal their intentions of taking US interest rates to zero without completely spooking the markets.
Thin trading going into the holidays can also exacerbate moves in the currency markets. I remember how the EUR/USD increased 300 pips between Christmas and New Years in 2007 and did the same in the first 3 trading days of the year.