ANALYSIS-Currency markets are in a deep freeze. Rate cuts and Trump could thaw it

Harry Robertson and Alun John reported that

LONDON (Reuters) - Traders and investors are looking to global interest rate cuts and a hotly contested U.S. election to yank global currency markets out of their lowest slump in nearly four years.

With the world's largest central banks in a holding pattern in recent months, measures of historical and expected volatility - how much prices have moved over a set period of time - have dipped, depriving foreign exchange traders of access to the divergent movements between bond yields in the regions they rely on.

Deutsche Bank's closely watched implied currency volatility index is near a two-year low, not far off its pre-outbreak level.

"So far this year, the music of the foreign exchange market has not started," says Andreas Koenig, global head of foreign exchange at Amundi, Europe's largest asset manager. Interest rates in the U.S. (bond market) are rising and falling, but other countries are following suit, so our spreads are unchanged."

"Who is going to cut rates first and by how much ...... and then the U.S. election, which is going to be the foreign exchange event, the macro event," Koenig said.

Central banks are taking their time. The Swiss National Bank became the first major central bank to lower borrowing costs in the current rate-cutting cycle in March. The Fed, ECB and Bank of England are expected to follow suit later this year.

While U.S. yields have risen in recent days as investors trimmed their bets on a Fed rate cut after stronger-than-expected data, eurozone bond yields have largely followed suit.

"What is causing the real volatility is the increased divergence between central banks," said Samuel Zief, head of global foreign exchange strategy at JPMorgan Chase Private Bank.

Trump card

Donald Trump last year proposed a generalized 10% import tariff if the former U.S. president of agriculture were to return to the White House.

"Tariffs, additional taxes mean that the dollar is likely to strengthen," said Themos Fiotakis, global director of foreign exchange strategy at Barclays.

Barclays Bank (Barclays) that if Trump is re-elected, the dollar may rebound on the support of tariffs 3%, and even said that the euro may fall to parity with the dollar.

Trump and Joe Biden appear to be on the same page at the moment, signaling heightened volatility in the $75 trillion-a-day global currency market as polls swing ahead of November's election.

Options allow investors to bet on currency prices, suggesting traders are bracing for moves in the Mexican peso, the Polish roti and the renminbi, all of which tumbled after Trump's 2016 victory, said Oliver Brennan, a foreign exchange volatility strategist at BNP Paribas.

"The volatility [of the three currencies] is really high in the nine-month to one-year range, and since nothing is happening right now, the volatility is really low," he said.

"If you look at any currency, there's going to be a kink around the November election, but the kink in these three currencies is huge."

Not worth trading

For now, the volatility slump limits opportunities.

"Looking at our current exposure, the allocation to currencies is significantly lower than the long-term average," said Jamie Niven, Senior Investment Group Carpet Manager at Candriam.

This is particularly true of certain currency pairs." Yusuke Miyairi, a strategist at Nomura, says: "It's not worth trading the euro against the pound at the moment. The pair's volatility is at its lowest since 2006.

However, there are signs that interest rate movements are beginning to drive small swings.

The Bank of Japan raised interest rates for the first time in 17 years in March, but that didn't stop the yen from falling to its lowest point since 1990, as traders realized that Japan's borrowing costs would remain at near-zero levels.

Strategists say this has led to volatility in Asian currencies, including the Chinese renminbi, showing how volatility in one region can ripple across markets.

Japan's direct intervention in backing its currency could lead to another shock.

In Europe, a Swiss interest rate cut helped the euro rise against the franc by the largest quarterly margin since the creation of the common currency.

Meanwhile, investors are doing their best.

We find carry-trading strategies particularly attractive if volatility is low," said Guillaume Rigeade, co-director of Carmignac's fixed-income division, referring to trades in which investors borrow low-interest-rate currencies to buy high-yield currencies.

Low volatility also makes it cheaper to hedge an equity or bond portfolio, he said.

JPMorgan's Ziff thinks there are worse times." He said, "At least we're in an environment of low volatility, but also arbitrage trading." Low volatility and very low interest rates ...... are worse.

(Reporting by Harry Robertson and Alun John; Editing by Amanda Cooper and Kirsten Donovan)