Currency Volatility Is Back as Geopolitics Add to Dollar Bets

(Bloomberg) — Volatility in the currency market is surging as traders bet renewed concerns over geopolitical tensions in the Middle East and faster-than-expected inflation in the US will propel the dollar higher.

A gauge for hedging swings in major currencies over the next month has jumped to the highest since January. The latest leg of the move was sparked by Iran’s attack on Israel, and comes after strong US inflation data last week fueled speculation the Federal Reserve will have to hold monetary policy tight for longer.

It’s a sudden turnaround for volatility, which only a month ago was extending its precipitous decline to fresh multi-year lows. The relative calm was looking so entrenched that many investors had started to wonder whether this was a new reality for the $7.5 trillion-a-day foreign exchange market.

Read more: Short Volatility Trades Are Starting to Rule Currency Markets

But traders are now reconsidering this benign outlook. The market is scaling back expectations on how much the Fed can ease interest rates this year, driving demand for bets on a stronger greenback against the euro to the most in a year, while lifting implied volatility.

There have already been hefty spot moves in major currencies as the market adjusts to this new backdrop. The euro and the pound slid to their lowest level since November against the greenback, while the yen extended losses Monday to hit a fresh low, its weakest since 1990.

The dollar is also benefiting from demand for havens given the Middle East tensions. That’s being reflected in appetite for bullish exposure to the Swiss franc as well, a switch in sentiment after its recent slump.

Even if tensions in the Middle East ease, volatility and currency hedging costs will likely stay above the multi-year lows seen earlier this year as bets on central bank policy divergence remain in place.

• NOTE: Vassilis Karamanis is an FX and rates strategist who writes for Bloomberg. The observations he makes are his own and are not intended as investment advice

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