Weekly Commentary on Future Asset Values

Updated with data through November 14, 2014

Latest Report

November 14, 2014 [PDF]


Commentary

The dollar strengthened as the euro, yen, metals and oil fell in price. Uncertainty increased in all of these markets as measured by the standard deviation of market-based probability densities (MPDs) derived from options. Banks and equity markets were relatively quiet during the past two weeks as price increased steadily.  Market expectations for inflation were stable during the period and the bias for higher short-term interest rates remained at historically low levels.

Inflation
Market probabilities for high inflation (based on caps and floors on the CPI) over the next two and five years increased slightly over the past two weeks but continue to remain at very low levels. Equivalently, the market probability of low inflation over these horizons remains elevated.

Chart 1

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Chart 2

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Interest rates
Spot prices for three-month LIBOR futures contracts that expire in three- and five-years continued to rise over the past two weeks from a mid-October low. While the skew of the MPD distribution for the three-year contract rose during this period, the skew measure associated with the five-year contact continued to decline. As noted two weeks ago, the market expectation calculated from options on LIBOR futures remains biased towards higher rates but the bias remains historically low.

Chart 3

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Banks and Insurance Companies
Financial firm equity saw modest gains in the last two weeks. The standard deviation of market probability densities was generally lower for insurance companies and banks. Trading volumes were light for many options on bank equity.
 
Additional Details:

  • Lincoln National experieced heavy trading of deep out-of-the-money options with strike prices 30 percent below the spot price. These trades occurred on days in which a company insider sold large amounts of stock. However, the price of the options and shape of the MPD only experienced a small change in response to this activity.

    Chart 4

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  • The option trading volume of Principal Financial rebounded to more normal levels and the probability of a 20 percent equity decline has fallen to 6 percent. This probability still remains slightly higher than most peer institutions, but it is consistent with levels experienced in the last year for the firm.

Other commodity markets
The dollar strengthened against the yen and the euro and the expected volatility in these currency markets continued to rise. Oil and metals declined in value and the standard deviations of the associated MPDs climbed noticeably. Agricultural commodities had small declines in volatility and mixed volumes.

Additional Details:

  • The euro continued to decline against the dollar during the past two weeks. Uncertainty about future level of the exchange rate also continued to rise as the standard deviation of the market probability density increased 56 basis points from 3.77 percent to 4.32 percent (the highest level since July 2013).
  • The dollar surged against the yen to a post-crisis high in response to the surprise announcement of additional quantitative easing at the end of October. The MPD for the dollar-yen exchange rate became flattened considerably and the probability of future large changes increased noticeably.

    Chart 5

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  • The price of gold fell 4 percent over the last two weeks. The standard deviation of market expectations increased 178 basis points and was skewed more negatively than two weeks ago. Despite recent declines, the option market indicators are increasingly pessimistic.
  • Silver MPDs standard deviations increased 364 basis points to 20.45 percent for 6 month contracts. Market uncertainty has increased during the last several weeks as prices have declined.
  • Tail risks measured in the market for WTI crude oil increased from our last report. Spot prices have fallen further and the MPD standard deviation fell by 190 basis points. The probability of another 20 percent price decrease has risen to over 15 percent.

    Chart 6

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