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The global picture on the volatility front hasn’t really changed in recent months. Implied and realized volatility is still hovering in their low or very low percentiles.
2017 the trading year is going out rather quietly into the night as far as FX vol markets are concerned. VXY has once again collapsed to the lows of the year with Fed risks out of the way and the holiday season in sight and delta-hedged returns over the past 2-weeks across various G10 FX blocs have been in the red with the exceptions of CAD- (oil-related whipsaw) and SEK- (post-CPI beat gyrations) crosses
A systematic short vol strategy delivered impressive returns this year. But value exhaustion is the main threat to a continued bear trend in vol: the VXY FX vol index is 1) in the bottom decile of the past 25 years, 2) 4-ppts lower than at the start of 2017, and 3) 1.5-ppts cheap compared to traditional macro drivers.
Set against this, the fundamental case for owning GBP volatility is straightforward and colored by uncertainty on multiple fronts – around the Brexit process, increasingly dysfunctional domestic politics, continued debate around the abrupt change in the BoE’s reaction function and the risk of an unwind of the 100bp of rate hikes priced along the yield curve should growth and/or politics intercede.
Yet current levels of implied vols are below pre-referendum levels from last year and below realized vol from the trading range of the past 3-6 months.
Long a 1Y vol swap in EURGBP. Opened at 8.85% November 21. Marked at 8.15%.
