Some more interesting news off of Bloomberg's site....
Currency Volatility to Hurt Carry Trade, Goldman Says (Update3)
By Liz Capo McCormick
June 14 (Bloomberg) -- Greater fluctuations in the prices of stocks, bonds and currencies probably will erode profits from the carry trade, one of the most popular investment strategies in the foreign exchange market, according to Goldman Sachs Group Inc.
A Goldman index that tracks three-month implied volatility on options on eight major currency pairs is at 6.03 percent, after reaching 5.78 percent last week. The record low, set in November, was 5.54 percent. Implied volatility, which traders quote as part of setting options prices, indicates expectations for future price swings.
``There is a good chance that we might be forming a bottom in foreign exchange volatility,'' said Jens Nordvig, a senior currency strategist at Goldman in New York. ``It might be difficult for the carry trade to sustain the type of performance it has had if the trend lower in volatility doesn't persist.''
Purchases of high-yielding currencies are financed in countries with lower interest rates such as Japan in the carry trade. Investors have started to speculate on future policy changes by central banks in Asia, Europe and the Americas, adding to asset price volatility.
``We've had a very prolonged global growth cycle that is getting into a mature phase,'' Nordvig said. ``Late in the cycle is when monetary policy become less clear'' to investors.
In the last few months, investors have flipped from pricing in possible interest-rate cuts to increases in both the U.S. and Canada, Nordvig said.
The Federal Reserve's target rate for overnight loans between banks is 5.25 percent, or 1 percentage point more than Canada's key lending rate.
Volatility Link
There is a close link between volatility and the performance of the carry trade as many investors analyze performance, not only by returns, but also by the variability of those returns, according to Nordvig. The so-called Sharpe Ratio, a benchmark by which many portfolio managers measure their performance, is the ratio of expected return to the variability of returns. An increase in volatility with no change in return will decrease the Sharpe Ratio. A higher ratio is more favorable.
Goldman advises clients to focus on carry trade investments involving emerging-market currencies like the Brazilian real or the Indian rupee, where return-to-risk prospects are better.
The benchmark lending rate in Brazil is 12 percent while India's is 6 percent.
Stock, Bond Swings
Rising global interest rates, including a surprise increase in benchmark borrowing costs last week by the Reserve Bank of New Zealand to a record 8 percent, was the catalyst for a general gain in volatility. The benchmark 10-year Treasury yield reached 5.327 percent yesterday, the highest since April 2002, and was little changed at 5.20 percent by 7:18 a.m. in New York.
``We've already seen volatility pick up in fixed-income and equity,'' Nordvig said. ``It is highly likely we won't get to new lows in foreign exchange volatility.''
Merrill Lynch & Co.'s MOVE Index, based on prices of over- the-counter options on Treasuries maturing in two to 30 years, rose to 85.2 on June 12, the highest since July 2005. The index had fallen to 51.2 in May, the lowest since April 1988 when Merrill began tracking the data.
The Chicago Board Options Exchange SPX Volatility Index, or VIX, rose to 17.06 on June 7, its highest since March. The VIX had fallen in January to 9.89, its lowest since December 1993. The VIX, based on Standard & Poor's 500 option prices, is considered a gauge of investor concern. Higher readings indicate less confidence about the market's prospects.
Three-month implied volatility on major currencies edged higher in the last week. Implied volatility on the dollar versus the yen rose to 6.45 percent, and that on the euro versus the dollar rose to 5.40 percent.
To contact the reporter on this story: Liz Capo McCormick in New York
Currency Volatility to Hurt Carry Trade, Goldman Says (Update3)
By Liz Capo McCormick
June 14 (Bloomberg) -- Greater fluctuations in the prices of stocks, bonds and currencies probably will erode profits from the carry trade, one of the most popular investment strategies in the foreign exchange market, according to Goldman Sachs Group Inc.
A Goldman index that tracks three-month implied volatility on options on eight major currency pairs is at 6.03 percent, after reaching 5.78 percent last week. The record low, set in November, was 5.54 percent. Implied volatility, which traders quote as part of setting options prices, indicates expectations for future price swings.
``There is a good chance that we might be forming a bottom in foreign exchange volatility,'' said Jens Nordvig, a senior currency strategist at Goldman in New York. ``It might be difficult for the carry trade to sustain the type of performance it has had if the trend lower in volatility doesn't persist.''
Purchases of high-yielding currencies are financed in countries with lower interest rates such as Japan in the carry trade. Investors have started to speculate on future policy changes by central banks in Asia, Europe and the Americas, adding to asset price volatility.
``We've had a very prolonged global growth cycle that is getting into a mature phase,'' Nordvig said. ``Late in the cycle is when monetary policy become less clear'' to investors.
In the last few months, investors have flipped from pricing in possible interest-rate cuts to increases in both the U.S. and Canada, Nordvig said.
The Federal Reserve's target rate for overnight loans between banks is 5.25 percent, or 1 percentage point more than Canada's key lending rate.
Volatility Link
There is a close link between volatility and the performance of the carry trade as many investors analyze performance, not only by returns, but also by the variability of those returns, according to Nordvig. The so-called Sharpe Ratio, a benchmark by which many portfolio managers measure their performance, is the ratio of expected return to the variability of returns. An increase in volatility with no change in return will decrease the Sharpe Ratio. A higher ratio is more favorable.
Goldman advises clients to focus on carry trade investments involving emerging-market currencies like the Brazilian real or the Indian rupee, where return-to-risk prospects are better.
The benchmark lending rate in Brazil is 12 percent while India's is 6 percent.
Stock, Bond Swings
Rising global interest rates, including a surprise increase in benchmark borrowing costs last week by the Reserve Bank of New Zealand to a record 8 percent, was the catalyst for a general gain in volatility. The benchmark 10-year Treasury yield reached 5.327 percent yesterday, the highest since April 2002, and was little changed at 5.20 percent by 7:18 a.m. in New York.
``We've already seen volatility pick up in fixed-income and equity,'' Nordvig said. ``It is highly likely we won't get to new lows in foreign exchange volatility.''
Merrill Lynch & Co.'s MOVE Index, based on prices of over- the-counter options on Treasuries maturing in two to 30 years, rose to 85.2 on June 12, the highest since July 2005. The index had fallen to 51.2 in May, the lowest since April 1988 when Merrill began tracking the data.
The Chicago Board Options Exchange SPX Volatility Index, or VIX, rose to 17.06 on June 7, its highest since March. The VIX had fallen in January to 9.89, its lowest since December 1993. The VIX, based on Standard & Poor's 500 option prices, is considered a gauge of investor concern. Higher readings indicate less confidence about the market's prospects.
Three-month implied volatility on major currencies edged higher in the last week. Implied volatility on the dollar versus the yen rose to 6.45 percent, and that on the euro versus the dollar rose to 5.40 percent.
To contact the reporter on this story: Liz Capo McCormick in New York