Tuesday, 8 January 2013

The Change in the Volatility Regime - a follow up

"If you change the way you look at things, the things you look at change." - Wayne Dyer, American psychologist   

While yesterday we touched on implications relating to regime changes in the volatility space, the phenomenon witnessed in the US is similar in Europe where European equity volatility trading has been trading marginally below the VIX as displayed in the below graph from Cheuvreux's recent Cross Asset Research paper from the 7th of January - The Tactical Message:
"The VStoxx index of implied volatility has followed the American example by falling to a cycle-low. The increase in America's political-fiscal risk premium since September has allowed indices of European equity volatility to trade marginally below the VIX." - source Cheuvreux Cross Asset Research, 7th of January 2013.

Cheuvreux makes the argument that the decline in financial volatility is a general phenomenon, with the lead coming from debt markets. They argue that there is more to it than financial repression:
- source Cheuvreux/Bloomberg
MOVE index = ML Yield curve weighted index of the normalized implied volatility on 1 month Treasury options.
CVIX index = DB currency implied volatility index: 3 month implied volatility of 9 major currency pairs.

"If the bond market’s move truly is the start of a long rates repricing for “good” reasons (namely finally validating the huge risky assets run-up of these last 4 months on better macro data) then it makes sense to see a risk transfer from the equities/forex sphere to the bond market’s sphere. As a matter of fact, we noticed this kind of discrepancy during a rather similar period : in Q4 of 2010, following the QE2 announcement, where we saw 10 year yield move up 100 bps, SPX and most risky assets rallyed hard with the same type of cross-asset vols opposite moves.

However these kind of disconnections in cross-asset vol markets generally do not last long. A correction in risky assets or a larger bond market rout would effectively probably see SPX and forex short volatilities move up rather quickly. We’re talking short-term volatility here so obviously timing is key to put on recorrelation trades as you need to be right pretty fast..."

At the time, of the bond market correction of March 2012, there was a similar disconnect, as indicated by Cheuvreux's graph between the CVIX and MOVE index, were Treasuries volatilities were up quite strongly and risky assets volatilities (equities and Forex volatilities remained at the low end of their recent range.

We can see a similar pattern in early 2013.

"Always remember that the future comes one day at a time." - Dean Acheson, American statesman

Stay tuned!

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