BNY Mellon: The Changing Nature Of Volatility

BNY Mellon: The Changing Nature Of Volatility

8 januari 2019

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By Simon Derrick – Chief Currency Strategist

By Simon Derrick – Chief Currency Strategist

Recent behavior in the S&P 500 has a familiar feel

The S&P 500 is continuing to provide an uncanny reprise of its performance in both late 2007/early 2008 and at the end of 2000.

While it’s certainly true that the composition of the index has changed substantially over the past decade and a half (Amazon joined in 2005, Google in 2006, Netflix in 2010 and Facebook in 2013), these comparisons help put in context the scale of the pressures building in US equity markets.

From a currency market perspective, the most interesting part of the reaction to heightened equity market volatility has not been the scale of the move seen last week in USD/JPY but, rather, what happened beforehand.

As noted a few weeks ago, the way realized volatility in USD/JPY has behaved has varied markedly between equity bull markets.

While it’s true that the first nine years of the 1987-2000 bull market were accompanied by a series of lower lows for three-month realized volatility in USD/JPY (measured on a close/close basis), these lows were interspersed by five major spikes higher.

Moreover, post-November 1996, realized volatility began to rise sharply. In contrast the 2002-2007 equity market rally saw USD/JPY realized volatility push steadily lower, with only one modest spike in mid-2004.

The post-2009 bull market also saw a unique pattern of realized volatility emerge in USD/JPY, with three sharp falls in volatility being interspersed by two equally sharp recoveries (the first being associated with the 2013 taper tantrum, while the second emerged around the time of the Brexit referendum).

It’s also noticeable that a materially greater number of low readings for realized volatility emerged during the recent bull market than during either the post-1987 or post-2002 rallies.

During the former move, no day registered a reading of less than 6%, while the latter saw just a brief period during the summer of 2007 when realized volatility fell below this level.

In contrast, the post-2009 rally saw 291 trading days (i.e. over a year cumulatively) with readings below 6%. Indeed, in the period between the start of July and December 25 of last year there was only one day that managed a reading of 6% (July 20).

 It seems fair to say based upon these observations that one of the defining characteristics of the recent bull market was lower realized volatility in USD/JPY than had proved the norm through much of the modern era.

However, it is also true that since 1980 lows below 6% in USD/JPY realized volatility have typically been followed by moves over the next year or so to readings above 15% (and, on occasion, north of 20%).

The question that therefore needs to be considered is quite how this volatility could emerge should pressures on equity markets build over the next few quarters.

We will look at this further over the next day or so.

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