Jim Reid: Volatile Volatility

In lieu of yesterday's monolithic moves across the spectrum of markets we cover, Deutsche Bank's Head of Credit Strategy, Jim Reid drops a Rosetta Stone on the real motive of the SNB's contradicting decision to strengthen the Franc, while lowering rates deeper into the NIRP abyss.

 Realized volatility started to spread from the energy space to other asset classes, most notably equities. Fixed income and currencies remained relatively sanguine about the risks posed by precipitously declining oil prices (with no end in sight), but hare recently caught up to the uncertainties the present us as we start a new year. Note the spike in FX's volatility after the SNB's move on Thursday

Realized volatility started to spread from the energy space to other asset classes, most notably equities. Fixed income and currencies remained relatively sanguine about the risks posed by precipitously declining oil prices (with no end in sight), but hare recently caught up to the uncertainties the present us as we start a new year. Note the spike in FX's volatility after the SNB's move on Thursday

 The day after a historic event. EURCHF a now trades around parity, after wrecking much more trading houses by spiking to as low as 0.75 minutes after the SNB's announcement 

The day after a historic event. EURCHF a now trades around parity, after wrecking much more trading houses by spiking to as low as 0.75 minutes after the SNB's announcement 

Volatility is something we place great emphasis on when making investing and trading decisions. This is something we have arguably been neglecting here at Business of Finance but plan to go into depth once time permits.

 A chart we published back in February 2013. We were correct in that 2013 and 1H2014 saw extremely low levels of volatility in US equities. See here is the term structure of the S&P 500 index from spot to 8-month forward

A chart we published back in February 2013. We were correct in that 2013 and 1H2014 saw extremely low levels of volatility in US equities. See here is the term structure of the S&P 500 index from spot to 8-month forward

My favourite quote from yesterday was from Citigroup’s CFO who when discussing their results said they were suffering from “volatile volatility”. This reminded us of Donald Rumsfeld famous “known unknowns” remarks a few years back. To be fair the last 24 - 48 hours give some credibility to the statement. At one point yesterday Oil had rallied nearly 14% from lows the previous day before falling some 10% from the highs. But of course the main story was the SNB’s currency play which led to a once in several generation move for the Swiss Franc. The price action was dramatic with the Franc immediately appreciating some 29% intraday against the Euro, touching a record low CHF0.852 before closing at CHF0.975 at the end of the European session, still around 19% stronger on the day. There were similar sharp moves against the Dollar. An initial 28% rally into intraday lows of CHF0.741 was pared back shortly after, but the Franc finished 18% stronger at the close against the Dollar at CHF0.839.

Indeed as a one-day upward move in a major currency its had few peers through history and is firmly in the top 10 of daily upward moves for any currency (vs the dollar) that we have data for which in many cases goes back into the nineteenth century. Most of the others in this top 10 are EM countries. So this is a rare event as when a peg gets abandoned and a big move ensues it’s usually a devaluation from a fixed rate system.

What makes this move shocking is that just last month the SNB committed themselves to preventing their currency appreciating beyond 1.20 to the Euro and vowed they would enforce the policy with “the utmost determination”. The risk for the global financial system is that if the SNB can make such a dramatic u-turn could other central banks follow at some point. We’re not so concerned here as their situation is arguably a lot different to the ECB. The ECB might actually look at the wider market moves yesterday and be scared to disappoint.

Once you artificially impact a market, changing course can be very painful. The other fear we have is with such volatility recently (and big declines), particularly in Oil and FX, will there be someone holding very bad positions and steep losses that will seriously impact their business and cause dislocations in other markets as stressed liquidations are forced upon them? Experience tells you there’s a chance but its not easy to anticipate. One to consider though and already people are looking to Eastern Europe where there are many Swiss currency mortgages. Also Bloomberg is reporting this morning that a NZ FX broker is shutting down its business and the largest US retail FX broker is facing some risk due to client losses both as a result of the move.

I was actually at one of our regular flagship macro dinners last night with 25+ clients and around 10 DB research, sales and traders. In the ones I’ve been at previously there have usually been much higher conviction than there was last night. It seems to me that confidence has been shaken by the events of the last say 3 months with confusion over Oil, EM, QE, rates, the global economy and now FX. Volatile volatility indeed!
— Jim Reid, Deutsche Bank

Again, as we've mentioned, this coming week's ECB announcement on monetary policy are what the markets will be anticipating from the get-go. Mario Draghi better not disappoint.