Currency hedges get costly as traders prepare for 2024 rate cuts

Demand is surging as traders bring forward their expectations for long-awaited rate reductions next year.

The cost of buying protection against currency swings is jumping as traders brace for a slew of data and central bank meetings that could shed light on the timing of a possible pivot to interest-rate cuts next year.

It’s the most expensive in four months to use options contracts as a hedge against dips or spikes in the euro versus the dollar over the coming week, when key US jobs and inflation data will be published.

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Doing the same for the dollar against the yen over two weeks — which straddles rate meetings at the Federal Reserve and the Bank of Japan — is the costliest since July.

Demand is surging as traders bring forward their expectations for long-awaited rate reductions next year. Central bankers’ frequent refrain that they’ll be guided by the economic data has heightened the importance of the remaining releases and policy-maker meetings of 2023.

“The shift in central bank policy rate cycles from hikes to cuts is keeping rate volatility elevated and finally putting some bid into currency volatility,” said Erik Nelson, macro strategist at Wells Fargo Bank.

Despite warnings that rate bets are too optimistic, market prices show a first 25 basis-point cut by the European Central Bank is almost fully priced in for March — compared with June just a week ago — and nearly 150 basis points of cuts for all of 2024.

That compares with about 130 basis points of easing expected for the Federal Reserve, which is seen making a start with its cuts a little later, in May.

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Ramped-up bets that the ECB may start cutting rates early in 2024 have prompted selling in the euro, which has retreated from a three-month high above $1.10.

A faster-than-expected deceleration in German inflation data last week helped to send one-week implied volatility in the euro-dollar pair up for six days straight, to 8.63%. The equivalent contract covering one month hit its highest level since early November.

Two-week volatility on the dollar versus the yen has jumped to 11.80%, a level last seen in late July.

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