Keith Underwood 2 Comments

Major currency pairs (GBP, YEN, USD, CHF) have seen significant increases of implied volatility over the course of the last several months.
Implied cross volatility pairs such as AUD/YEN and NZD/YEN have moved into crises levels not seen since 2011.
Equity portfolio managers re-hedging (liquidating dollar positions), against established long USD positions.
Market uncertainty of what the Yellen cakehole cannon might say tomorrow.


Equity portfolio managers (PM’s) are heading for the door. They have been selling winners (Netflix and Amazon for example) to lock in profits against the losses incurred on their dogs (European energy and banking). This liquidation (fancy word for sell at market order or ’Get me out!’) of positions is forcing PM’s to hedge their resulting USD exposure. They have sold USD aggressively over the last several months in the face of a market that has been long USD positions.

Caught in the middle of the dollar are the currency crosses that are indicators of extreme uncertainty and of the potential of a crisis in the making. Think of AUD/YEN and NZD/YEN as proxies for crises indicators and now that implied volatility in those crosses are close to 20% (Asian and Lehman crises levels), typical liquidity providers like banks are curtailing their risk by widening spreads (1 week volatility being 3 or 4 percent wide). Wide spreads correlate to higher volatility and are a defensive mechanism to protect the banks that have now greatly reduced their risk tolerance, which regulators have imposed.

Markets hate, hate, hate uncertainty. With the Yellen testimony to Congress just over 24 hours away, currency investors are fretting about what she might or might not say. Should she let’s loose a dovish comment (typical Yellen) about a rate rise for June instead of March, the dollar is toast and volatility will drop. If she mentions lower for longer or data dependent, the market will trade sideways and gamma will get crushed. If she stays the course and mentions a gradual increase then the dollar will resume its accent and volatility will most likely continue to rise as a result.
Quick, discreet, and so worth the risk.


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