High uncertainty and subdued volatility

Morning FX

After the sharp drop in Korean stocks and yen intervention, market volatility in August has returned to a low point. The 1Y implied volatility levels of G7 currencies have remained below 6.5%.Actual volatility of EUR, JPY, and KRW only briefly rose, and trading interest in the market remains sluggish.

Chart: The slump in Korean stocks did not trigger a spillover in sentiment

From a traditional perspective, the FX market should be vibrant when uncertainty is high. However, the emotion from Korean stocks did not spill over, the VIX index fell below 15, the S&P 500 index hit a new all-time high, and the divergence from volatility keeps widening.

1. Everything Remains Unresolved

There are at least three major uncertainty themes in the current market.

First, the prolonged US-Iran war makes the path for oil prices highly unpredictable. Brent crude oil prices have returned to 90 and have hovered above the 80 mark for the past two months. The most pessimistic forecast at the beginning of the war was that high oil prices would last until year end, but now it seems they may persist even longer.

Second, weak US economic data puts the Federal Reserve in a dilemma, and whether rates will be raised within the year remains highly uncertain.The sharp divergence in economic signals makes it impossible for the market to anticipate the Federal Reserve's policy path.

Third, bond issuance is difficult due to fiscal concerns. Long-term bonds have become insensitive to oil prices, the US has entered a new cycle of bond issuance, and demand remains weak. The 10-year US Treasury yield has already risen to levels seen before the rate-cutting cycle, while the 30-year yield has broken through a 20-year high.

Chart: Global long-term bond yields rising

2. Why Is the Market So Calm?

The market is abnormally calm, because uncertainty depends entirely on data and events,and lacks trading value resulting from differences.

US signals across the board are sharply diverging: nonfarm payrolls, corporate earnings, consumer confidence, and inflation data all show varying trends, and conclusions depend entirely on the perspective. The Federal Reserve’s core inflation targets are still noticeably above its policy goal, but the turning point could trend either up or down. The only clear main trend is the continued deterioration of US fiscal conditions, which is also the underlying logic behind the rise in US Treasury yields.

Chart: Volatility keeps trending lower

In addition, this year’s returns in the FX and US Treasury markets have been quite poor, far inferior to equities and commodities. Speculative money has rotated from gold, to AI stocks, to commodities.After the Middle East war, the market entered chaotic, event-driven volatility. Untransparent communications from the Federal Reserve have made it the biggest X factor, and the market is unwilling to place big bets amid uncertainty.

3. Summary

(1) After a wild July, volatility has returned to a low, and trading interest is scarce.

(2) Despite lingering uncertainty, weak returns are keeping capital on the sidelines. Investors can only wait for a new trading mainstay (such as last year's de-dollarization) to ignite the market again.