Foreign Exchange Markets' Risk Aversion Spikes Before US Jobs Data

The foreign exchange markets are witnessing a notable increase in hedging costs, following a period of relative calm during the summer. This rise comes as traders brace for potential price volatility triggered by the monthly US jobs report due on Friday.

On Thursday, the overnight implied volatility for the euro against the US dollar rose to its highest level since June and appears poised to register its strongest closing performance since April. This surge reflects the importance traders place on jobs data in assessing the Federal Reserve's next moves.

Federal Reserve Chairman Jerome Powell, in a speech last month, indicated that "downside risks to the labor market are increasing." Data released on Wednesday, showing a drop in US job openings in July to their lowest level in 10 months, further intensified the focus on Friday's jobs report. Weak data could fuel expectations of a more aggressive easing of monetary policy by the Federal Reserve, potentially weakening the dollar.

Elias Haddad, a strategist at Brown Brothers Harriman, explained that "August jobs data will determine whether the market starts betting on a 50 basis point rate cut by the Federal Reserve on September 17, while the market currently anticipates a 25 basis point cut."

Other Factors Influencing Market Volatility

Jobs data are not the sole driver of volatility. This week, a broad index measuring the expected volatility of G10 currencies rose to its highest level in a month, due to factors including fiscal concerns in the UK, the political situation in France, geopolitical tensions, a series of central bank meetings, and concerns about the Federal Reserve's independence.

The one-week euro volatility also rose to a two-month high on Thursday, as it covers the upcoming European Central Bank meeting and US inflation data. A closely watched options gauge that monitors the difference between implied and actual volatility showed contract prices at their highest levels since January.

Although the market expects the European Central Bank to not adjust its policy, recent statements by policymakers have opened the door to raising interest rates, and their forward guidance is crucial. The US CPI data on September 11, along with Friday's jobs data, will set the tone for this month's Federal Reserve meeting.

The British pound is also attracting safe-haven demand. As traders prepare for potential market volatility that may result from Finance Minister Reeves' budget on November 26, the three-month relative hedging cost for the pound has risen to its highest level since January.

George Saravelos, a strategist at Deutsche Bank, noted that global concerns about fiscal policy are creating a "perfect storm," leading to higher bond yields and a weaker pound.