Volatility Rises on Demand to Hedge Against Yen Gain
bloomberg.com
July 3 (Bloomberg) -- Volatility on major currencies may extend a rebound from an all-time low because investors are buying protection against a rally in the yen.
Traders are holding record futures bets that Japan's currency will weaken versus the dollar, which raises the risk they will exit so-called carry trades that profit from yen declines, said David Woo at Barclays Capital Inc. Concern about losses in the riskiest segment of the U.S. mortgage market may make investors more risk-averse, sparking a reversal of carry trades and bigger currency swings.
``Volatility will be creeping higher,'' said Woo, head of global currency strategy at Barclays in London. ``Dollar-yen volatility should lead the way'' because of concern that the carry trade will reverse, leading investors to buy options protecting against a slide in the dollar.
For major currencies, volatility on options was 6.38 percent yesterday, the highest since May 2, according to a JPMorgan Chase & Co. index gauging three-month implied volatility. The index touched 5.73 percent on June 5, the lowest since the bank began tracking the data in June 1992.
The dollar traded at 122.37 at 2:05 p.m. in Tokyo from 122.42 late in New York yesterday. It reached 124.13 yen on June 22, the strongest since December 2002.
Speculators' Bets
Investors using the carry trade strategy borrow at Japan's lower interest rates to purchase assets where yields are higher. The Bank of Japan's key overnight lending rate is 0.50 percent, compared with 5.25 percent in the U.S.
Speculators including hedge funds held 188,077 more futures contracts betting on yen losses than on gains last week, up from 161,361 a week earlier, according to figures from the Washington- based Commodity Futures Trading Commission. Six weeks after these so-called net short bets reached their prior record in February, JPMorgan's currency volatility index surged to the high for this year.
``There is an underlying pattern of increasing volatility evolving,'' said Jens Nordvig, a senior currency strategist at Goldman Sachs Group Inc. in New York. Concern about the outlook for so-called subprime mortgages is ``adding to the reasons for an increase in volatility.''
Ten-year Treasury yields fell to a three-week low yesterday on speculation weakness in the riskiest mortgages will undermine the housing market. A National Association of Realtors report today is forecast by economists to show pending sales of existing homes rose in May from the lowest since February 2003.
Rate Expectations
Investors borrowing in yen and investing in U.S. short-term rates have earned 5.3 percent this year, according to Bloomberg data. Among major currencies, the best-performing carry trade this year has been the New Zealand dollar versus the yen, with an 18.4 percent return. New Zealand's benchmark rate is 8 percent.
The Bank of Japan will lift its benchmark rate to 0.75 percent by the end of September, according to the median forecast of economists surveyed by Bloomberg News from June 11 to June 22.
``Volatility will pick up again if expectations for a Bank of Japan August rate hike rise,'' said Uwe Parpart, head of fixed-income and foreign-exchange research at Cantor Fitzgerald Capital Markets in Hong Kong. A rate increase can lift demand for the yen.
Implied volatility on one-month dollar-yen options reached 8 percent last week, the highest since April. The rate has rebounded from 5.725 percent on June 5, the lowest since Bloomberg began tracking the data in December 1995.
Traders quote implied volatility, a gauge of expectations for swings in exchange rates, as part of setting option prices.
`Too Risky'
Carry trade bets are ``too risky'' at present, said Gokhan Akan, who oversees $1.3 billion in assets as co-fund manager of North Asset Management LP's MaxQ Fund Limited in London. Potential losses in corporate debt because of weakness in subprime mortgages may ``spill over into foreign exchange.''
Akan said he currently isn't holding any carry trade bets in his portfolio because of the risk of increased volatility.
The premium for options that protect against a slide in the dollar versus the yen rose to the highest last week since April.
The so-called one-month risk-reversal rate on dollar-yen options fell to minus 1.65 percent last week, and traded today at minus 1.70 percent. A negative figure indicates greater demand for dollar puts that grant the right to sell the currency, relative to calls giving the right to buy.
This past weekend's terrorist attack at Glasgow International Airport and two attempted car bombings in London last week also decreased investor demand for risky investments, said Neil Jones, head of European hedge fund sales at Mizuho Financial Group Inc. in London.
``We've seen a desire by investors to protect downside risk'' on bets the dollar will gain, Jones said. ``There has been demand for dollar puts and yen calls.'' |
