When long volume becomes a “no brainer” - Nomura

Analysts at Nomura explain that the market volatility is painfully low and we should be worried that the summer lull may be upon us as the political risk themes of 2016 have played their part, but from here the macro risk environment still lacks a catalyst to be long vol.

Key Quotes

“Its time will come, but timing is key and we think vols may have further to fall before then.”

“A common strategy across FX, rates and equity markets is to systematically sell implied volatility, earning the volatility risk premium from it (even when vols are low). As vol selling strategies are still selling, even here at historically low levels, it does require a market catalyst to lead to that regime shift. It is a question the market is soul searching for, yet none have materialised thus far in 2017.”

“The current move lower in FX volatility is reminiscent of sentiment in 2014, when vols reached historical lows and it took an oil supply shock to revert higher. It is therefore ironic that just like 2014 the oversupply in oil markets is back in focus again. So if you are a fan of small sample sizes, as in 2006/07 and in 2014, when vols fell to such extreme lows, the lesson learnt was that it can be difficult for six months or so with negative returns to being outright long vol. Eventually, the upside was worth the wait, but it hurt.”

“What is key is figuring out the inflection point of when vols start to look attractive.”

“As most of the known risk events such as the French presidential election have passed we would be selective in our choice of long vol structures here at these levels. On a broader basis, we would argue that without another clear macro catalyst over the next month, until the June ECB meeting at least, perhaps a repeat of those 2014 lows may be upon us for the time being.”  

“We have also previously argued that the ongoing discussion on the divergence between hard and soft data can be a driver of low volatility. We believe the debate on convergence – whether from the hard data picking up or the soft data winding down – is unlikely to be resolved any time soon. History tells us that the hard data should pick up, but it lags the soft data by around eight months. Given the eight-month lag structure, the market will only know if the hard data have caught up or not by the late Q2/Q3 period. This means growth expectations are unlikely to change in the interim, pointing towards low implied volatility in the meantime and a carry-seeking environment.”