Euro Volatility May Catch Up to Pound’s Brexit Premium: Analysisby
Implied volatility in the euro hasn’t kept pace with a surge in a similar measure for the pound, even as some investors look to hedge risks linked to a potential U.K. exit from the European Union using euro-dollar options. There is scope for the gap to narrow as euro-area political risks resurface, Bloomberg strategist Vassilis Karamanis writes.
Three-month pound-dollar implied volatility has exceeded 16 percent, hitting levels unseen in six years, while a six-month gauge reached 14.53 percent peak on April 7. The spread between six-month pound-dollar volatility and a similar euro-dollar measure widened to a record of almost 4 percentage points on April 13.
While Brexit risks seem largely priced into sterling options as polls predict a very narrow result, the odds of the event causing heightened euro-dollar volatility are still off investors’ radar. Among the possibilities is a U.K. exit triggering a confidence blow to European cohesion or reviving “Grexit” fears, especially after a five-month delay in Greece’s bailout review negotiations.
The probability that one of the euro-area countries will leave the Union within a 12-month period has almost doubled since an October low of 11.3 percent, as the sentix Euro Break-Up Index suggests. Still, it remains well off the highs seen last year and in the summer of 2012. This probability has been rising amid spreading anti-EU sentiment, as demonstrated by the recent Dutch vote on treaty with Ukraine and Le Pen’s rising influence in France.
Should Greek bailout talks drag into the summer, raising solvency concerns, or the U.K. vote to leave the EU, this probability may extend its advance, dragging euro volatility along as it did during the height of last year’s Greek crisis.
Six-month euro-dollar volatility, currently at 10.30 percent, may revisit levels seen last June near 12 percent, narrowing the gap with pound’s Brexit premium. The tenor includes a series of events that carry large tail-risks:
- The U.K.’s EU referendum is on June 23.
- Spain elections may take place on June 26, if a government isn’t formed by May 2.
- Analysts warn that Greece will be unable to meet its July 20 financing needs without a release of bailout funds by then.
- The Federal Reserve meets on June 15 and July 17, with market assigning low probability of another interest-rate increase by then; the European Central Bank meets on June 2 and July 21.
Note: Vassilis Karamanis is an FX and rates strategist who writes for Bloomberg. The observations he makes are his own and are not intended as investment advice