[B]Implied volatility is one of the most tried and true methods for objectively measuring expected volatility in the spot market. Derived from currency options with different maturities, implied volatilities are used to help predict potential movements in the spot market and is one of the most popular strategies of systems traders and other professional hedge funds.[/B]
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Implied volatility has advanced on the week following a resurgence of carry trade interest. With EURJPY flows widely dictating the majors direction for the past several weeks, it isn?t much of surprise to see long and short components rise higher. For the week, the longer term implied measure has climbed to 6.7 percent compared to last week?s incrementally lower 5.65 percent. The short long spread, notably, has jumped to above the zero line at 45 basis points. Given the recent volatility, and labor day weekend in the US , the lower implied targets will likely keep the pair in a range environment until the traders return from vacation.
Pound sterling has climbed higher, however, implieds have fallen on lower activity in the market. For the week, the longer terms have comparably come back a bit, now priced at 6.925 percent against last week?s higher 7.35 percent. Subsequently, the short term picture has also declined, leading the spread to narrow considerably below the zero line. Now trading at 17 basis points wide under the benchmark, the reading compares to a 3 bps spread last week. In similar fashion, volatility should be at a low level, keeping the sterling in a relatively steady environment.
The breakdown that we saw in the USDJPY has helped to support volatilities much higher over the course of the week. The longer term component is now higher trading at 14.5 percent with the differential widening to trade a whole 2.4 points above the zero line. Given the extreme readings on the implied measures, ranging conditions continue to be favored even as the currency fluctuates wildly. The end of summer lull should help in paring back activity in the next week, supportive of the range reading.
USDCAD has remained in a range bound scenario as expected by our volatility model even as implieds have increased on both ends. Longer term implieds have increased to trade at 10.8 percent compared to a slightly lower 10.45 percent seen last week. Subsequently, the short-long differential has jumped to 95 basis points wide. Ultimately, even as implieds continue to climb higher, we remain steadfast in our assessment that the underlying currency will continue to be range bound given the extreme reading of our longer term component.
Australian dollar implieds have surged higher as the underlying spot advanced over the course of the week. Longer term implieds rose to trade at 15.75 percent compared to last week?s weaker 13.10 percent. Differentials have also improved, widening to 275 basis points against 265 basis points last week. As a result, with components as high as they are we remain steadfast in our model?s range assessment.
[B]Written by: Richard Lee, Currency Strategist[/B]