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The JPMorgan G7 Volatility index this month fell below eight.
Apparently traders are more sanguine about major forex than at any time since the outset of the financial crisis. The volatility component of options are cheap.
But something’s not right. The JPMG7’s recent decline came during a time that saw the dollar index move up and down like a fiddler’s elbow.
Furthermore, the chart below shows the JPMG7 with the UBS V24 Carry index (inverted), which measures total returns from borrowing in lower-rate currencies to buy higher-yielding peers, the so-called carry trade.
Low vols, and bullish market sentiment, have traditionally encouraged carry trades.
Bloomberg calculates that interest rates in the G10 economies will average 0.53 per cent in 2012, against 6.39 per cent for the Brics. That’s good for carry, too. The Brazilian real’s vols are also near record lows.
But since mid-August the correlation between the vol and carry gauges has broken.
Forex vols look out of whack. One explanation, says Simon Derrick at BNY Mellon, is “in the absence of any real yield from $, Y, € etc, holders are forced into finding returns from elsewhere. That might include selling options.”
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