Weekly Commentary on Future Asset Values

Updated with data through July 24, 2014 new

Latest Report

July 24, 2014 [PDF]


Commentary

Shorter-term risk-neutral expectations for inflation receded slightly last week while LIBOR rate MPDs remained largely unchanged. Trading was active in options on bank stocks as firms reported second quarter earnings. Spot prices remain weak for physical commodities as tail risks continue to move higher in those markets.

Inflation
The median expected inflation rate over the next twelve months, as derived from caps and floors on the CPI, pulled back slightly since our last report. The MPD skew for twelve month inflation also fell and moved from positive to negative, suggesting more downward bias in risk-neutral expectations in the near term.

On the other hand, the pullback is less notable at two year and five year horizons and the trends in MPD statistics that we have previously reported remain intact. For example, at the two year horizon MPD skew remains elevated relative to the beginning of the year and the interquartile range is lower. This indicates continued risk-neutral bias toward higher inflation and shrinking risk-neutral uncertainty.

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LIBOR Rates
LIBOR rate MPDs remain stable. The risk-neutral expectation at the median of the MPD for the two year time frame continues an extremely slow climb. Five year risk-neutral expectations for LIBOR have changed little this year.

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Banks & Insurance Companies
Since our last report, share prices are generally higher for banks and insurance companies. Both industries, on average, underperformed the S&P 500. Larger banks generally outperformed smaller banks.

Since the end of last year (12/26), the median share price in our universe of banks (CCAR 17) and insurance companies (10 largest market capitalizations) has remained largely unchanged. Similarly, the median standard deviation and skew of the MPDs derived from options on bank and insurance company share prices have been remarkably stable. MPD standard deviations are slightly lower (second figure below).

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  • Trading in options on bank shares was brisk as a number of firms reported second quarter earnings results. We highlight C, BBT, COF, FITB, JPM, KEY, MS, and STI as firms whose shares had relatively high options trading activity associated with earnings reports. Tail risks for these firms generally fell as indicated by their MPD standard deviations.
  • Trading in options on insurance company shares was more subdued as market participants waited for upcoming earnings reports.

Other Commodity Markets
Options trading on many of the commodities we follow was strong last week. In most cases, tail risk, as measured by MDP standard deviations, remained steady at low levels. At the same time, prices were generally lower including spot prices in the grains, precious metals, and crude oil markets.

Additional Details:

  • Tail risks, as measured MPD standard deviations derived from options on futures prices, were higher relative to two weeks ago for the grain markets we follow. Spot prices fell for all three commodities: -5.9% for corn, -0.9% for wheat, and -3.6% for soybeans. MPDs skewed toward lower prices form corn and wheat. (See corn, soybean, and wheat reports.)
  • There was strong activity in options on cattle futures. Spot prices in this market rose 3.5% over the past week. Tail risks in this market are increasing. (See cattle report.)
  • Near-term options trading on exchange rate futures was relatively strong. Tail risks are very low at this time in each market we follow. (See exchange rate reports.)
  • The skew derived from options on 10 year Treasury bond futures reversed direction over the past two weeks. The less negative skew value indicates decreased downward bias in bond price (risk-neutral) expectations or, equivalently, decreased upward bias in rate (risk-neutral) expectations.

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