Stressed FX Markets – Nomura
Bilal Hafeez, Research Analyst at Nomura, suggests that if we rewind to
the middle of February and markets were in turmoil and the S&P500
was plummeting to two-year lows, credit spreads were exploding higher
and oil was testing $25 a barrel.
“Fears of a Chinese hard-landing, European bank instability and the reverberations of the Fed’s December hike – its first in almost 10 years – were engulfing the market.
Fast-forward to today and that period seems like a distant memory. Admittedly, the Bank of Japan did provide another market shock by not easing in late April, but it does not appear to have been enough to tip markets back to those dark days in February. Indeed, if we look at an array of risk measures from equity volatility to credit spreads we find that the bulk of them are not too far away from their one-year averages. In February, they were all over two standard-deviations above the average.
The one measure that is still in elevated risk or “stressed” mode is FX volatility. While it has fallen in recent months, it remains one standard-deviation above its one-year average. Other measures such as credit spreads have been on a steady decline. Part of this is that the EU referendum in the UK is on the horizon which FX markets are most sensitive to, but also it suggests that FX is perhaps the lightning rod for all risk. If there’s a tremor anywhere, FX markets will likely take notice.
The implication of this is that only when nerves in FX markets subside can we have any confidence that the instability is behind us. Until then, markets are likely to remain skittish on whether risk is on or off.”