What seemed unthinkable for currency volatility just a few weeks ago could soon be a reality.
Turbulence has awoken from lethargy that sent hedging costs to record lows last year to reach multi-year highs. It may just be prepping the scene to revisit levels seen when the global financial crisis crippled markets in 2008, several gauges suggest.
At a time when the economic effects of the pandemic remain unknown, the ability of central banks to respond to the crisis is questioned and a stock rout deepens, investors have no hesitation about paying up and hedging.
One-month implied volatility in dollar-yen rose above 24% on Thursday to trade at levels unseen since January 2009. One-week volatility posted its widest one-day advance on record on Monday, only to hit a fresh cycle high on Thursday. The yen three-month cross-currency basis swap, meanwhile, is heading for its widest drop since September on a one-day net basis, and its fourth widest since 2015.
The moves follow a rush to borrow dollars as investors seek refuge against the risk of a global recession, and mark a sharp turnaround from last year. Volatility dropped after U.S.-China trade tensions and concerns of a hard Brexit kept most central banks from considering any tightening plans.
Risk reversals in dollar-yen, a gauge that shows the premium at which calls trade over puts and reveals market positioning and sentiment, are now trading at record levels in favor of yen calls. The increased demand for yen calls in the past week is so steep it suggests investors in panic mode.
Another driver of higher hedging costs is that volatility is cheaper compared to turbulence in stocks and equities. As the correlation between foreign-exchange spot prices and volatility grows, there is even greater scope to turn to currencies to own exposure over risk moves. Even comments from the China National Health Commission that the peak of the virus outbreak in the country is generally over weren’t enough to offer any calm.
* Vassilis Karamanis is an FX and rates strategist who writes for Bloomberg. The observations he makes are his own and are not intended as investment advice