FxWirePro: A Quick Run Through on FX Vols and USD-Correlations

The U.S. dollar rises on impeachment risks, so far the FX market has reacted quite calmly to the news that the US Democrats have initiated an impeachment inquiry against President Donald Trump.

While FX vols stay on side-lines while uneasy calm persists as USD correlations drop below 40% for the first time since 2016.

An eye-popping vol carnage dominated the FX vol space in September as risk sentiment turned around after the challenging August. The Aug spike got halved. VXY-GL term structure shifted lower (refer 1stchart) and the 3M tenor is now only 1vol above the July multiyear low with the implied – realized gap at 1.2vols still weighing on FX implied vols. 

Amid the vol sell-off, delta-hedged straddles broadly succumbed (refer 2nd chart), but it is the breath of the long gamma MTD suffering that gives one a pause. Septembers seasonally tend to be one of the softest vol months and the current September proved that point. That said, the oil shock over the weekend still has potential to upset that bearish September FX vol stance even though the FX spot and vol reaction so far has been fairly contained. 

Potentially a bad omen for FX vol shorts, USD correlations dropped below 40%, the first time since 2016 (refer 3rdchart). We are closely watching for signs of a mean-reversal higher which is not a question of if but of when. Such reversals have been historically associated with upticks in USD vols. 

The question is whether there are still FX vol pockets where a short vol expression is plausible. Amid the overall backdrop, we are inclined to tactically and selectively harvest risk premium only in safe pockets of oil isolated EM and with the longevity of such short vol stance highly uncertain we prefer limited downside structures, as discussed below. Courtesy: JPM