Updated with data through July 24, 2014
July 24, 2014 [PDF]
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.
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.
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.
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).
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.
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