Weekly Commentary on Future Asset Values

Updated with data through September 19, 2014

Latest Report

September 19, 2014 [PDF]


Commentary

Risk neutral expectations for inflation at or above the Fed’s 2% target continue to decline. Bank and insurance company MPD standard deviations increased over the past two weeks suggesting a higher risk of tail events. Options trading was active for exchange rate futures last week. In particular, MPDs derived from options on dollar-pound futures exhibited market concerns about downside risk ahead of the Scottish independence vote.

Inflation
Inflation expectations derived from CPI caps and floors declined for all expiries. The median expected inflation rate over the next 12 months declined 22 basis points to 1.47% over the last two weeks. The decline was similar for the median inflation rates derived from caps and floors with two and five year expiries. The declines were 16 and 11 basis points respectively. The risk-neutral probability of inflation below 1% has increased to 31% over the next 12 months and 23% over the next two years. The risk-neutral probability of inflation above 3% over the next two years is now 8%, a four year low.

Chart 1

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Chart 2

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Interest rates
The ten year treasury rate MPD is largely unchanged relative to two weeks ago. Spot prices decreased slightly (interest rates increased) over the last two weeks. The skew decreased and is negative indicating bias toward higher interest rates.

Banks and Insurance Companies
Options trading on financial equity securities with 6 months to expiry showed generally higher volumes relative to the last report. MPD standard deviations for banks generally rose even as share prices did likewise. This is in contrast to the MPD standard deviation derived from options on the S&P 500 index which declined slightly. The MPD standard deviations for most banks remain low relative to standard deviations measured over the last 4 years.

Chart 3

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The average insurance company shares underperformed banks by about 180 basis points over the past two weeks. Like the bank MPDs, insurance company MPD standard deviations were mostly higher.

Additional Details:

The MPD standard deviation derived from options on AFLAC experienced a large increase on high volume last week. The standard deviation for AFLAC moved closer to the industry median. This is notable in that the property and casualty firms tend to exhibit less tail risk than the median. Our data indicated a similar increase to the MPD standard deviation based on PGR options, another property and casualty company.

Chart 4

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Other Commodity Markets
Trading volumes were low in most commodity markets we track and spot prices declined in each of the markets we follow. Tail risks as measured by MPD standard deviations were higher with the exception of the grain markets.

Additional details:

  • Spot prices declined meaningfully for corn, soybeans, and wheat futures over the past two weeks (-1.5%, -1.9%, and -6.1% respectively) where they stand at five year lows. Risk-neutral probabilities of large downside price moves are also near five year lows suggesting limited expectation of additional large declines.
  • Spot prices on 6 month gold futures dropped -2.4% and spot prices on 6 month silver futures dropped -2.1% over the past two weeks. At the same time, the skews derived from MPDs related to the options on these futures also declined indicating increased market based expectations for even lower prices.
  • As oil prices continue to decline, the standard deviation of the MPD derived from options on WTI crude futures has increased. Though this tends to indicate increased tail risk, the current absolute level of tail risk remains historically low.

Chart 5

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  • The standard deviation of the MPD derived from options on dollar-pound futures increased 92 basis points. The MPD skew declined to the lowest level we have measured over the last 4 years. These large changes are occurred on high volume and likely reflect market uncertainty surrounding the independence vote in Scotland. Volumes were more concentrated at out of the money strikes favoring a stronger dollar. The changes in the shape of the MPD indicate increased down side risk to the pound

Chart 6

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