(BLOG) Morning Brief- Wednesday, Aug 29

1. High Yield Volatility

Low volatility supports risk markets, but as we saw earlier in the year, it can create complacency which is often followed by sharp market corrections. It is odd that realized volatility in the S&P and the US HY markets is so low given the movements in emerging markets assets. Such divergences don’t last long.


Why it Matters

Realized volatility in the high yield markets just set a new low for the year. 10-day realized volatility on HYG is a mere 1.2% (blue line below). Equity volatility is also hovering at the lowest level of the year.

2. EEM vs SPY

Emerging and international markets matter to US companies, especially the technology sector where more than 50% of the revenue comes from overseas. A slowdown overseas and/or a strong USD will eventually curtail profit growth. As you can see from the chart, these market divergences in volatility tend to not last very long.

Ratio of EEM to SPY Vol

Why it Matters

The ratio of realized 30-day volatility in emerging market equities (EEM) to US equities (SPY) is approaching the highest level in the last 10 years. Realized volatility on EEM is 2.7 times that of SPY. There is a similar situation in FX that was highlighted last week.

3. FX Risk Reversals

The elevated price for USD calls/BRL puts highlights the concern for Brazil. The options market is pricing in a high probability for further weakness, which in a perverse way, may mean the worst is over. The reverse is true for the Yuan where CNH put buying has slowed.

BRL Risk Reversal

CNH Risk ReversalWhy it Matters

One way to follow the sentiment in markets is to look at “risk reversals” in the options markets. This is simply the difference in implied volatility between calls and puts with similar deltas. The 1-month risk reversal for USD/BRL is at an extreme whereas the risk reversal for USD/CNH is fading.

4. Commercial Paper Spreads

Commercial paper spreads continue to contract to Treasury Bills. The spread between 3m CP and 3m T-Bills is down to 14 bp. It was as high as 50 bp in April. All the stress in US money markets appears to be gone.

3m CP BIlls Spread

Why it Matters

Low stress in money markets means attractive entry points for positions that will benefit if the stress resurfaces. The entry point for a long swap spread position in short-dated Treasuries is very good at the moment. Unlike the purchase of outright options, it is not expensive to hold.


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