Updated with data through October 3, 2014
October 3, 2014 [PDF]
Risk neutral expectations for inflation continue to fall. Bank and Insurance company share prices also fell accompanied by increased tail risks. Tail risks for commodities also rose while prices fell as the dollar continued to strengthen.
Inflation expectations for the next 1, 2 and 5 year periods continue to decline. MPDs derived from caps and floors on the CPI now show a 34% chance of inflation falling below 1% over the next twelve months and expectations of high inflation have declined below 5%.
Expectations for inflation over the next 5 years have also declined. The median of the MPD is currently 2% and risk neutral probabilities of large changes are at five year lows.
Trading in options on the ten year Treasury futures expiring in three months was strong which is common at the start of quarters. The MPD skew is now positive for the first time in twelve months indicating a slight bias in market expectations toward lower rates in the near term.
Banks and Insurance Companies
Options on share prices of financial institutions generally traded at low volumes both relative to history and relative to two weeks ago. Share prices were uniformly lower for both banks and insurance companies. The average bank fell about -3.3% over the past two weeks while the average insurance company fell -3.6%. Tail risks, as measured by MPD standard deviations, moved higher as did MPD skews. This is the standard MPD behavior we witness when prices decline.
rading in options on Deutsche Bank shares increased relative to our last report. We noted trading activity at strike prices well above and below the current spot prices (see graph below). At a smaller magnitude, we measured similar activity in options on Bank of New York Mellon shares (see report details). This trading behavior is consistent with higher tail risks and increased uncertainty about future price moves.
Other commodity markets
As the dollar continues to strengthen, commodity and currency futures spot prices continue to fall. Â The decline in grain prices has been dramatic. Year to date wheat has declined 6%, corn has declined -20% and soybeans have declined 25%.
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