Swings Suppressed as World Volatility Reveals No Panic
Price swings across assets and around the world are holding below historical averages even as central banks roil markets.
Levels of investor concern in equities, commodities, bonds and currencies as measured by Bank of America Corp.’s Market Risk index of cross-asset volatility are below readings from about 75 percent of days since 2000, according to data compiled by Bloomberg. Among those markets, the cost of options has risen in Treasuries and foreign exchange in 2013 and fallen in stocks and raw materials.
Daily fluctuations have widened in the past month amid speculation the Federal Reserve might consider curtailing its quantitative easing program of stimulus and reports on Chinese and American manufacturing that trailed estimates. The increases have done little to increase expectations for price swings to historical levels after volatility tumbled amid rallies that added $5 trillion to global equity values this year and pushed bond yields to record lows.
“We don’t expect a big increase in volatility because monetary policy is still generally too stimulative,” Joost van Leenders, who helps oversee $657 billion as a strategist at BNP Paribas Investment Partners in Amsterdam, said in a phone interview yesterday. Central-bank policy makers are “not going to remove quantitative easing quickly. They will do it gradually to see how markets react and if markets become too volatile, they will move more cautiously.”
Investors have been encouraged to buy riskier assets as global central banks unleashed unprecedented monetary stimulus after the financial crisis of 2008. Concern that the policies would be reviewed grew last month following comments from Fed Chairman Ben S. Bernanke and Bank of Japan Governor Haruhiko Kuroda.
Bernanke said during a response to questions following congressional testimony on May 22 that the central bank could consider reducing the $85 billion in monthly Treasury and mortgage debt purchases within “the next few meetings” if officials see signs of improvement in the labor market. Kuroda said last month that the Bank of Japan is seeking to reduce bond market volatility after embarking on a program to double the nation’s monetary base in two years to end 20 years of deflation.
The Bank of America Merrill Lynch gauge, a component of their Global Financial Stress Index, closed at minus 0.49 yesterday. While it has risen from a five-year low in January, the gauge remains about 75 percent below readings over the past 13 years.
A negative number means lower-than-normal volatility expectations based on data going back to 2000. The index measures future price swings implied by option markets in global equities, interest rates, currencies and commodities.
“Despite the recent rise in volatility, derivatives markets appear relatively confident that central bank actions globally will suppress volatility and support risky assets,” Abhinandan Deb, the London-based head of European derivatives strategy at Bank of America, said in a phone interview. “Options are still attractively priced in a number of markets.”
Nowhere is the impact of stimulus more evident than in U.S. equities, where the Standard & Poor’s 500 Index has closed at record highs 17 times this year and the Chicago Board Options Exchange Volatility Index was within 18 percent of an all-time low in March. While the VIX increased more than 30 percent in the last two weeks of May, it remains 14 percent below its historical average.
Options on the VIX show investors may be preparing for lower volatility. Call open interest fell to 6.37 million before contracts expired on May 21, down from a record 7.72 million in March. The ratio of outstanding calls to buy the VIX versus puts to sell slipped to 2.02-to-1 on May 28, the lowest level since Jan. 7, the data show.
“We’re not seeing the same build-up in bets on the VIX rising,” said Todd Salamone, an equity analyst at Schaeffer’s Investment Research in Cincinnati. “Some people may simply be giving up on bets on higher volatility or on using VIX calls as a hedging tool.”
Volatility will return when policy makers begin a process of normalizing monetary programs set in place since 2009 to counter the effects of the financial crisis, according to Patrick Armstrong of Armstrong Investment Managers LLP in London.
“We could be in an environment with much higher volatility going forward once central banks end their non-conventional measures,” Armstrong, a managing partner at the firm, which oversees about $350 million, said by phone yesterday. “Once they start to taper, the Bernanke put is removed. Then you’ll start to see higher demand in volatility. Investors were willing to take risk because that put was there.”
The S&P 500 has lost 3.6 percent since Bernanke’s comments to Congress two weeks ago. The Fed has pledged to maintain record-low borrowing costs as long as the jobless rate remains above 6.5 percent and the outlook for inflation doesn’t exceed 2.5 percent.
The Labor Department report tomorrow may show the unemployment rate remained unchanged at 7.5 percent in May, according to the median economist forecast from a Bloomberg survey. Personal income as a percentage of output is 43.8 percent, the lowest level since at least 1947, according to data from the Fed Bank of St. Louis.
Global markets will face increased volatility as central banks bring interest rates back to normal levels, JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon said today.
“We should all hope for a normalization of interest rates -- that’s a good thing,” Dimon said during a panel discussion at the Fortune Global Forum in Chengdu, China. “As we go back to normal, it’s going to be scary, and it’s going to be kind of volatile.”
While swings in Treasury yields have risen on concern the central bank may scale back debt purchases, they remain below post-financial crisis highs. The 10-year Treasury (USGG10YR) yield climbed as high as 2.23 percent on May 29, the most since April 2012. It retreated to 2.09 percent yesterday.
Bank of America Merrill Lynch’s MOVE Index (MOVE) was 83.64 on June 5, up from a low this year of 48.87. The gauge, which measures volatility based on prices of over-the-counter options on Treasuries maturing in two to 30 years, is below the average of 101.51 since the start of 2007.
“Volatility in the bond market had gotten abnormally low because of the Fed’s easing policies,” Nick Stamenkovic, a fixed-income strategist at RIA Capital Markets Ltd. in Edinburgh, said during a telephone interview on June 5. “Now doubts have surfaced as to how long the Fed is going to maintain QE at its current pace and hence some uncertainty has been injected in the market and volatility has picked up accordingly. But we have not seen this spread to equity markets or credit markets.”
The rise in Treasury yields has created increased movements in exchange rates, though projected fluctuations are near long-term averages.
A JPMorgan Chase & Co. index of global foreign-exchange volatility that tracks options on currencies of major and developing nations was 10.01 on June 5, compared with an average of 11.43 through 2007. The index, tracking implied volatility of the most actively traded currencies and those of emerging markets, is up from 8.07 at the end of December.
Implied volatility, which traders quote and use to set option prices, signals the expected pace of swings in the underlying currency.
“The set-up for the second half is going to be for strong growth,” Michael Darda, chief economist at MKM Partners LLC in Stamford, Connecticut, said in a telephone interview on June 5. “We should not be worried about rising long-term yields because it’s a sign that the economy is recovering. The Fed has been successful in pushing inflation expectations back up to about the 2 percent level and promoting growth.”
The 60-day historical volatility measure for the S&P’s GSCI Spot index of 24 commodities in February reached the lowest since December 1995. The price-swings gauge is down 77 percent since reaching an all-time high in December 2008. Cattle and hog prices were the most stable this year. Natural gas and silver had the highest variations.
Gold has been whipsawed amid speculation about the pace of the Fed’s monetary easing. The metal’s 60-day historical volatility touched the highest since December 2011 on June 5, and a gauge of price swings for the SPDR Gold Trust, the biggest bullion-backed exchange-traded fund, surged 55 percent this year.
A strengthening U.S. economy has helped support asset prices. Growth increased at a “modest to moderate” pace in 11 of 12 Federal Reserve districts, with broad-based gains ranging from business services to construction and manufacturing, the central bank said yesterday.
“The Fed is tightening when it thinks economic conditions are robust,” Tristan Hanson, who helps oversee about $1.5 billion as head of asset allocation at Ashburton Ltd. in London, said in a phone interview yesterday. “So if conditions are robust and Fed guidance is clear, then you may not see the big increase in volatility.”
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