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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
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• JPMorgan vol index and EUR and JPY 3M volatility
THE GREAT MODERATION IS OVER JPMVXYGL INDEX
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• JPMorgan vol index and EUR and JPY 3M volatility, long term
THE GREAT MODERATION JPMVXYGL INDEX
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• 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
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• 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
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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
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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
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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
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Current Market Taper Tantrum
Q3 2011 2008 Financial Crisis
Very flat vol term structure
SIMILAR HISTORICAL PERIODS VOLC FOR EURUSD
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• The risk reversal is at very elevated levels (bid for EUR puts)
RATIO 25DELTA EUR PUT / ATMF CIX
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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
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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
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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
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