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Master Class:
Return of Volatility to the
FX Markets
Annie Grebenyuk | Francesco Tonin FX Market Specialists
Central Banks Balance Sheet Expansion - ECWB<GO>
GDP forecast comparison for G10 economies - ECFC<GO>
The size of the ECB balance sheet – BI LTRO<GO>
The size of the Fed balance sheet – BI BANKN HILID<GO>
The surge in FX volatility – VCA<GO>
The increase in Implied - Realised vol spread – WCRS<GO>
The change in FX volatility – VOLC<GO>
AUD/USD Volatility Smile Lower – OVDV<GO>
Possibility of next rate cut by RBA – WIRP<GO>
Demand for EURUSD calendar spread – GP<GO>
The change in steepness in EURUSD vol curve – XCRV<GO>
The change in spot vs RR correlation – VOLC<GO>
The recent change in favour of USD calls – VCA<GO>
• Volatility across the world has increased over the past six months
THE GREAT MODERATION IS OVER WVOL
16
• JPMorgan vol index and EUR and JPY 3M volatility
THE GREAT MODERATION IS OVER JPMVXYGL INDEX
17
• JPMorgan vol index and EUR and JPY 3M volatility, long term
THE GREAT MODERATION JPMVXYGL INDEX
18
• Collapse in commodity prices
FACTORS BEHIND 2015 VOLATILITY CL1 COMDTY
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• De-peg of EURCHF: • Global event? No
• Orderly market? No • How to prepare and profit from it?
• Can you trade it after the de-peg?
FACTORS BEHIND 2015 VOLATILITY EURCHF CURNCY GIP
20
• The Sharpe ratio of the FX carry trade declined during the second half of 2014
EFFECT OF VOL ON THE CARRY TRADE WCRS
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• Returns were similar six months ago, but the realized volatility was half as high
EFFECT OF VOL ON THE CARRY TRADE WCRS
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Much higher realized volatility over the last six
months vs. a year ago
• The carry trade suffered dramatically during Q4 2014
CARRY TRADE PERFORMANCE FXSW
23
SIMILAR HISTORICAL PERIODS VOLC
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Taper Tantrum
Second Greek Crisis
First Greek Crisis
Euro Sovereign Crisis Starts
2008 Financial Crisis
SIMILAR HISTORICAL PERIODS VOLC
25
Taper Tantrum
Second Greek Crisis
USD Debt Downgrade & First Greek Crisis
Euro Sovereign Crisis Starts
2008 Financial Crisis
Earthquake
Three Arrows Economic Policy
SIMILAR HISTORICAL PERIODS VOLC
26
Taper Tantrum
Second Greek Crisis
USD Debt Downgrade, USDBRL, USDIDR Jitters & First Greek Crisis
Euro Sovereign Crisis Starts
2008 Financial Crisis
Earthquake in Japan
SIMILAR HISTORICAL PERIODS OVDV FOR EURUSD
27
Current Market Taper Tantrum
Q3 2011 2008 Financial Crisis
Very flat vol term structure
SIMILAR HISTORICAL PERIODS VOLC FOR EURUSD
28
• The risk reversal is at very elevated levels (bid for EUR puts)
RATIO 25DELTA EUR PUT / ATMF CIX
29
Before the Financial Crisis
EURUSD RR is not very interesting
Start of the Euro Sovereign Crisis
Greek Bailout Taper Tantrum
SIMILAR HISTORICAL PERIODS OVDV FOR USDBRL
30
Current Market Taper Tantrum
Q3 2011 2008 Financial Crisis
Very flat vol term structure
SIMILAR HISTORICAL PERIODS VOLC FOR USDBRL
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• The risk reversal is at quite tame levels despite spot performance
RATIO 25DELTA BRL PUT / ATMF CIX
32
2008 Financial Crisis
The hayday of the skew
Relative Cheapness of Tail Risk
SELL THE SKEW IN USDBRL OVML
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• Backtesting of 3m ATMF vs 25D USD call spread in USDBRL
SELL THE SKEW IN USDBRL CONTROL GROUP OVML
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• Backtesting of buying 3m ATMF Straddle vs selling 3m 25D Strangle in USDBRL
• Factors that played a role in the classic definition of the great moderation
• Reduction in the volatility of real economy indicators
• Central banks control financial asset prices but not directly the real economy
• Urban myths
• The Fed creates asset bubbles
• Bubbles burst and volatility rises
• Tail risk insurance is a good deal
• Factors that are playing a role this time
• Real wars: Russia, ISIS
• Currency wars: ECO, BoJ
• One-time shocks: EURCHF, USDARS
• Significant vol rise across the market
• Volatility curves showing long term high vol trends
• Higher price of risk in EURUSD / Lower price of risk in USDBRL
FINAL CONSIDERATIONS
35