Updated with data through September 19, 2014
September 19, 2014 [PDF]
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 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.
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.
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.
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.
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.
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