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10 Sep 2014
Volatility is back, at least in FX - J.P. Morgan
FXStreet (Łódź) - John Normand, FX Strategist at J.P. Morgan states that following a summer of multi-years lows in trading volumes, September opens with an increase in volatility.
Key quotes
"Over the past two months, VXY has rallied over two percentage points to 7.5%, a move that sounds trivial in absolute terms but is actually quite large from a base level near 5% in early July."
"The jump is also bigger proportionally than what is occurring in equity and some rate markets, as VIX and US swaption vol continue to respect their summer ranges (mainly bund swaption vols are rallying). What gives?"
"Just a confluence of Fed fears (US 2-yr rates are threatening a new three-year high), European secession risks (the Scottish referendum with a read-across to a UK vote on EU membership) and rising odds of ECB QE."
"There is a more interesting, underlying story unfolding, however: a year-long undershoot of FX vols brought on by a remarkably stable global business cycle and extremely loose central bank policy is reversing for somewhat familiar reasons."
"How much further could vols move? Even after this summer's rally, VXY is still priced two vol points too low for the current global macro environment of 2.9% global real GDP growth, 2.6% global CPI inflation and volatility in growth and inflation at about the same levels as early 2014."
"So as Great Moderation 2.0 makes its way out of the building over the next few months, it’s likely to leave the hallways a bit messier than they are now for the simple reason that vols have still not worked off their misalignment."
"Stay long a handful of the relatively cheap hedges in the interim (long 6-mo USD calls vs 6M6M FVAs in AUD and ZAR; long AUD/JPY vs USD/JPY puts; long NZD/USD vs USD/MXN straddles)."
"We’re not convinced that this fall will be as bad as the taper tantrum since USD longs are materially longer than they were 18 months ago, mainly due to huge euro and yen shorts."
"But the current valuation signal from VXY is nonetheless a reminder that market pricing is not yet normal."
Key quotes
"Over the past two months, VXY has rallied over two percentage points to 7.5%, a move that sounds trivial in absolute terms but is actually quite large from a base level near 5% in early July."
"The jump is also bigger proportionally than what is occurring in equity and some rate markets, as VIX and US swaption vol continue to respect their summer ranges (mainly bund swaption vols are rallying). What gives?"
"Just a confluence of Fed fears (US 2-yr rates are threatening a new three-year high), European secession risks (the Scottish referendum with a read-across to a UK vote on EU membership) and rising odds of ECB QE."
"There is a more interesting, underlying story unfolding, however: a year-long undershoot of FX vols brought on by a remarkably stable global business cycle and extremely loose central bank policy is reversing for somewhat familiar reasons."
"How much further could vols move? Even after this summer's rally, VXY is still priced two vol points too low for the current global macro environment of 2.9% global real GDP growth, 2.6% global CPI inflation and volatility in growth and inflation at about the same levels as early 2014."
"So as Great Moderation 2.0 makes its way out of the building over the next few months, it’s likely to leave the hallways a bit messier than they are now for the simple reason that vols have still not worked off their misalignment."
"Stay long a handful of the relatively cheap hedges in the interim (long 6-mo USD calls vs 6M6M FVAs in AUD and ZAR; long AUD/JPY vs USD/JPY puts; long NZD/USD vs USD/MXN straddles)."
"We’re not convinced that this fall will be as bad as the taper tantrum since USD longs are materially longer than they were 18 months ago, mainly due to huge euro and yen shorts."
"But the current valuation signal from VXY is nonetheless a reminder that market pricing is not yet normal."