A new research note from CME Group looks at whether FX options skews can be used to predict where certain currencies will move relative to the US dollar.Written by Erik Norland, executive director and senior economist at CME, the research opens by explaining that options markets typically exhibit a skew, but that in different asset classes this skew can be in different directions.For example, Norland points out that out-of-the-money (OTM) put options on equity index futures are usually more expensive than OTM call options because investors fear a sudden decline in stock prices more than a sudden rise. However, the reverse is generally true for options on agriculture products because food buyers are more concerned with a sudden increase in the price of crops rather than a decline.
Having taken a look at Galen Stops’ predictions for 2018, Colin Lambert decides that overall he didn’t do a bad job, but there is an obvious reason why…Obviously having been a very generous marker over the years when assessing my own predictions from the previous year I have now swung 180 degrees and plan on being as critical as possible when looking at Galen’s five key themes for 2018. The problem is that, overall, he didn’t do too badly. Firstly, he suggested that 2018 could be the year that active currency management makes a comeback, although – and this is a theme of this review – there was a caveat because the headline ended with the words “sort of”.
We’d all like to write our own reviews, but if the recent emphasis on third party transaction cost analysis (TCA) has taught us anything it’s that it can be beneficial to have an independent party conduct reviews too. With that in mind Profit & Loss challenged some of its readers to look over our 2018 predictions and provide feedback.Prediction: “The Great Divide” – 2018 will be all about the data and it will empower those willing to pay for it, however there will be challenges for those who cannot or will not pay up to consume and store the vast amounts of data required. Those with data will be more protective of how their pricing is used by counterparts and those without will struggle in an increasingly fragmented market as more platforms package and sell their data.
A new research report from JP Morgan Chase Institute highlights the impact of central bank communication choices on financial market volatility.In the report, Does the Timing of Central Bank Announcements Matter?, the authors analysed data around the Swiss National Bank’s (SNB) decision to remove the EUR/CHF floor in January 2015, and found evidence that the timing of the decision increased subsequent market volatility.This latest research builds on a previous paper released by JP Morgan in June 2018, in which it found evidence that many hedge funds had predicated trading strategies on the belief that the SNB would maintain the EUR/CHF floor at 1.20.
In this week’s podcast Colin Lambert and Galen Stops tackle two big stories in the FX market: the recent flash crash in the Asia markets and the changes at Citi’s FX prime brokerage (FXPB) business.Both Lambert and Stops express skepticism that the news regarding Apple’s profits in China was the cause of the flash crash, although the former is equally unsure about an alternative theory put forward by the latter to explain the price moves. Both agree though that the event was symptomatic of changes in the nature of liquidity in the FX market, and note a disparity between what many market participants will say in private and in public on this matter.
The euro performed well in 2017, but can it keep going? Galen Stops suggests that political factors mean that this currency could surprise markets in 2018.
This time last year, the European Union was still grappling with the fact that one of its biggest members was poised to leave the club, people were nervous about a populist, anti-EU party winning the Dutch general election, and even more nervous about a populist, anti-EU party winning the French election and presidency.
As a result, markets were – understandably – pricing a lot of risk into the Eurozone.
Data from CLS shows that the first round of the French presidential election caused a much stronger reaction in the spot FX market than the second round.
The data shows that there was a significant spike in volumes following the first round of voting. Ahead of the vote, polls were showing a statistical tie for the top four candidates, and therefore the result was much more uncertain.
Before polling was suspended by law on Friday, 21 April 2017, Bloomberg’s composite of French polls showed Emmanuel Macron in the lead with 24.5 % and Marine Le Pen in second place with 22.5% of the vote
Last year the FX market was highly event driven, with periods of sustained low volatility occasionally punctuated by large but episodic market moves.
Looking ahead to 2017 and there are already clearly some events set to take place that have the potential to drive further bursts of volatility, namely the invocation of Article 50 by Britain to begin its exit from the European Union and the scheduled political elections in France, Holland and Germany.
In addition, the change of policy direction expected under US Presidential-elect, Donald Trump, and the US Federal Reserve’s indication at the end of 2016 that it currently plans to raise rates three times this year are expected to be major drivers of the currency markets in the coming year.
The US Federal Reserve increased interest rates by a quarter point today, also indicating that it now expects to increase rates three more times in 2017.
“In view of realised and expected labour market conditions and inflation, the committee decided to raise the target range for the federal funds rate to half to three-quarters per cent. The stance of monetary policy remains accommodative, thereby supporting some further strengthening in labour market conditions and a return to 2% inflation,” says the Federal Open Market Committee in a statement issued today.