Cross-Asset Volatility Rising as Markets Brace for Brexit Risks
(Bloomberg) -- With just a week to go for the result of the U.K.’s EU referendum, currency volatility is surging while that in rates, stocks and inflation markets have only recently picked up as investors position for what could be the year’s biggest event risk.
- With with recent polls skewing toward a “leave” vote, uncertainty is running high and liquidity is disappearing from markets, Bloomberg strategists Tanvir Sandhu and Vassilis Karamanis write
- Here’s a summary of cross-asset volatility trends ahead of the Brexit vote:
CURRENCIES
- Liquidity in currency options has dwindled as most major banks are unwilling to quote bid-offer spreads in the front- end unless it suits their own risk profile, creating large distortions
- Implied volatility term structure in GBP/USD has hit its most inverted skew ever
- One-week soared Friday by as much as 29 vols to all time- high of 49.7%, before retreating to 33.46%
- Spread versus EUR/USD vol surges initially to record high ~30 vols, then pares gain to trade at 15 vols
- Previous high was 8.25 vols in Sept. 2014 ahead of the Scottish referendum
- One-month in cable drops a 3rd day as demand for protection further down the curve wanes; trades at 25 vols, compared to 29.5 vols on June 15
- 1-mo., 1-yr skew flattens to 13% from 16.1% record seen on June 13 and may drop further as referendum nears
- Risk reversal spread between 1-mo. and 6-mo. narrows from its all-time-low last Friday at -4.5 vols to -3.98 currently
- Since June 2009, it turned negative only in Sept. 2014, before reversing to positive territory after Scottish vote
RATES, INFLATION
- Sterling long-expiry rate volatility finally woke up this week to Brexit risks as polls skew toward a “leave” vote, although it still remains below past year’s highs
- Term structure of 10y tenor GBP swaption volatility has now turned negative for 2m expiry vs 1y while it is near zero for 3m vs 1y (see chart here), sluggishly attempting to narrow the gap with deeply inverted FX counterparts
- GBP 1y10y implied vol vs USD has now hit the highest level since at least 2011 however, the absolute GBP rate vol still remains below YTD high of 90bp/annual
- Steepening of bund volatility skew in favor of calls reflects increasing Brexit risk premiums and investors positioning for increased bond scarcity (see chart here)
- Downside options may come into play early next week where a vote to “remain”, in line with betting odds, will see an unwind of Brexit premiums in bunds and renewed Fed hawkishness weighing on global bonds
- Growing risk of Brexit has rekindled GBP inflation vols amid surging cost of protecting against pound’s downside, with lure of relative value pushing up inflation premiums from trough
- Any perception GBP weakness due to increased odds of the U.K. leaving the EU could push up price pressures in the economy
- The premium demanded to bet RPI will rise to 2% in 2 years has risen to 156bps from all-time low of ~57bps (see chart here); more here
EQUITIES
- S&P 500 has only recently started pricing in Brexit risks with the term structure spread between 1-month and 1-week volatilities approaching multi-year highs
- A kink has formed in the chart of weekly options expiring post EU referendum; see chart here
- FTSE vs SPX 1-mo. implied volatility spread has widened to 15 vol points, most since 2008; see chart here
- VStoxx-VIX spread is the widest in more than a decade after recent polls showed a lead for the “leave” campaign
- U.K. equity funds saw the past decade’s 2nd largest weekly outflow of USD1.1b in the period to June 15; 19 straight weeks of outflows from European equity funds: BofAML
- NOTE: Tanvir Sandhu and Vassilis Karamanis are strategists who write for Bloomberg. The observations they make are their own and are not intended as investment advice
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