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With volatility plumbing multi-decade lows, traders across all asset classes are starved for volatility, not just in equities and bonds, but also across FX crosses. There is no assurance that Yellen's Friday statement, which many say has been priced into asset prices, will do much to move the vol needle. Or perhaps it will if one trades those assets which have shown the most sensitivity to Fed surprises.
Conveniently, Goldman's FX strategist Robin Brooks has prepared an analysis looking at which 3 currencies one should trade to get the highest bang for the vol buck on Friday, or as he puts it: "Which Dollar Cross Responds most to Fed Surprises? "
As Brooks notes, Goldman has run regressions that link each of the G10 Dollar crosses (EUR/$, $/CAD, AUD/$, NZD/$, $/JPY, $/CHF, $/NOK, $/SEK, GBP/$) to the two-year interest rate differential, the Euro zone fiscal risk premium, the VIX as a proxy for global risk appetite and the Brent oil price to proxy for global commodity price trends. Goldman explains its methodology further as follows:
The chart below shows the average response of Dollar crosses to a one-basis-point change in the two-year rate differential from 2006 to today (blue) and for the last three months (red). Based on the results for the last three months, which Goldman sees as a good template for correlations going forward, a 10bp move of the two-year rate differential in favour of the Dollar, say in the event of a hawkish surprise on Friday, could move GBP/$ 1.5 percent lower. In contrast, $/JPY could go 1.3 percent higher on our estimates. As a result, Brooks finds that GBP/$, $/JPY and NZD/$ are three most rates-sensitive Dollar crosses, i.e., they have the largest potential to move should there be a material surprise on Friday. Meanwhile, $/SEK, EUR/$ and $/CHF are the least rates-sensitive crosses, at least based on data for the last three months.
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