Implied Vol Repression

Two things occurred in Tuesday’s session

That led to implied vol repression

First Powell agreed

There was still a need

For rates to rise with some discretion


Then later a story explained

The UK and EU attained

A framework accord

England could afford

Though different than Brexit campaigned


The North Koreans launched their latest, most sophisticated ballistic missile and it comes third in terms of importance to the market, maybe fourth if you consider the hype surrounding Bitcoin’s breaching the $10,000 level! We live in interesting times.

Arguably, yesterday’s morning session was dominated by Fed Chair-designee Jay Powell’s confirmation testimony before the Senate Banking Committee. In it, he displayed the requisite characteristics of a Fed Chair, he only spoke clearly about what he wanted to discuss, and evaded all other questions effectively. However, he seemed extremely explicit in effectively confirming that the FOMC would be raising rates by 25bps next month, and that the wind-down of the Fed’s balance sheet would continue at a gradual pace, probably draining some $2 trillion from markets over the next few years. He would not be drawn into a discussion of Fiscal policy, and he signaled his belief that there is sufficient regulation of financial markets at this time, perhaps even too much. The dollar response to his comments was generally positive as the broad dollar index rose about 0.4% in the aftermath.

But then, around 12:45, news hit the tape that the UK and EU had agreed a framework for the so-called divorce bill resulting from Brexit. This has been one of the key issues preventing the opening of trade negotiations and so was rightly heralded as a huge breakthrough in the process and a positive for the pound. The market response was an immediate 1.25% jump in the pound. Since then, it has actually traded somewhat higher and is the G10 leader today, up nearly 0.5% vs. the dollar. Of course, there is still the question of the Irish border to be addressed and that is no easy task. While Ireland wants to have no physical border between itself and Northern Ireland, one has to wonder how that can work if both sides are in different economic unions. My point is all the progress can still be scuttled, but for now the market is quite pleased with the terms. An interesting side note is that the probability of a BOE rate hike moved from December to September next year on the news implying tighter monetary policy is coming sooner to a screen near you. While that was arguably part of the reason for the rally in cable, it still makes no sense to me. UK data continues to underwhelm and when the BOE did raise rates earlier this month, it seemed pretty clear this was a one-off event, trying to remove the excess accommodation offered in the immediate wake of the Brexit vote last year. However, the fact that the UK economy didn’t collapse subsequently has convinced them that rate cut was no longer needed. That is a far cry, though, from the idea that they need to raise rates into the greatest economic uncertainty for the UK economy since the financial crisis. I continue to believe that the BOE will not be raising rates until well after March 2019, when the UK actually leaves the EU. As to the pound, it continues to feel overvalued to me here as I believe the market is ascribing too much benefit from this outcome.

Moving on, the market response to the North Korean missile launch was remarkably sanguine, with a short-term rally in the yen of just 0.4%, which eroded steadily throughout the session. In fact, on the back of the Powell dollar bullishness, the yen actually ended the session weaker by 0.35%. Since then, there has been little additional movement. Perhaps even more remarkable was the fact that KRW actually rallied throughout the session, finishing stronger on the day despite the dollar rally and further extending those gains overnight. The point is despite the Nork’s claiming they can now launch a nuke anywhere in the world; neither investors nor traders seem to care. I mean what’s more important, the growing possibility of a nuclear war or the fact that Bitcoin has risen above $10,000? Obviously, it is the latter! (As Bitcoin does not yet qualify as a currency in my mind, it is not likely something I will mention frequently. However, it is important to be aware of the story because if you are looking for a potential catalyst for increased volatility, the bursting of that bubble has to be one candidate.)

And there you have it. Aside from the pound, the G10 has been far less interesting with regard to price movement. The laggard this morning is SEK (-0.3%) after Sweden released softer than expected GDP figures. However, the Riksbank doesn’t seem to have changed its tune regarding policy because of one number. There has also been some discussion about AUD, where two-year yields have crossed under their US counterparts for the first time since 2001. Back then, AUD fell to its historic lows of ~0.50, and while the Fed continues to push rates higher, there is no sign that the RBA is going to follow. Frankly, it seems there is further room for the Aussie dollar to fall. Happily for hedgers, the cost of hedging AUD receivables has collapsed due to the differing rate expectations. So don’t miss out here. Even five year forwards are only a one cent discount.

This morning’s data will be watched carefully, I believe, as the release of the second cut of Q3 GDP (exp 3.2%) along with the concurrent Price data has the potential for an impact if it is off target. We also get the Fed’s Beige Book this afternoon, and quite soon, German CPI is due to print (exp 1.7%) which is a precursor to tomorrow’s Eurozone number. However, if the GDP data is in line with expectations, I imagine that we will continue to see equity markets drive investor sentiment ever higher, which means that risk will continue to be embraced. In this market, that actually means EMG currencies should do well, and ironically, so should the dollar. Interesting times indeed!


Good luck






2 thoughts on “Implied Vol Repression

  1. I think the bursting of the bitcoin bubble would be a market story but wouldn’t lead to much volatility in real markets. There’s just not enough money invested there. Tesla bursting would have a much bigger impact IMO.

    Michael Ashton, CFA
    Managing Principal

    Enduring Investments LLC
    W: 973.457.4602
    C: 551.655.8006

  2. I hear you about the relatively small size, but I think it would be more of a psychological issue. After all, isn’t Bitcoin the culmination of the portfolio balance channel? As to Tesla, I agree with you there, but don’t want to upset too many people who are fans!

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