FX: Still Waiting

To say that the foreign exchange market is quiet is to bemoan the obvious.  What is particularly striking is that the euro’s range yesterday may have been among the smallest and today is matching it, thus far.  According to Bloomberg data, yesterday’s range was 17 ticks.  

Looking at the volatility implied by the options market exaggerates the low actual volatility.  Consider, for example, that the options market implies 4.5% euro-dollar volatility (one-month). The actual volatility is 3.1%.  This is, of course, more than the term structure or the vol smile can justify.  It partly reflects fear that volatility may rise sharply.   It may also partly reflect dealers reluctance to take on the risks and costs without getting compensated.  

A similar pattern is found in sterling.  Implied one-month volatility is just below 4.6%, while actual volatility over the past month is 2.5%, the lowest among the major currencies.  The implied one-month yen vol is 4.9% and actual volatility is 3.5%.   

The US dollar is slightly firmer today, while the 10-year US Treasury yield is a bit softer at 2.47%.  China and Japan stock markets extended yesterday’s gains, while the other Asian markets were mixed.   European bourses are mixed, leaving the Dow Jones Stoxx 600 little changed, with earnings reports lifting financials and telecoms, but weighed down by the auto sector after Renault’s cash burn rate disappointed investors.   

Bond markets are mostly firmer and German 10-year bund yield hit a record low near 1.12%.  Spain’s 10-uear is also at a new record low of 2.46%, edging just below the US.  While the fact that Spanish yields have fallen below US yields has become a talking point, what is often missed in the discussion is what is happening to real rates.  Given the near zero inflation in Spain, the real yield is almost identical with the nominal yield.  In the US, with near 2% inflation, the real yield is almost 50 bp, a fifth of Spain’s.