Oil: Lower implied volatility justifies reduced FX sensitivity - Nomura
Analysts at Nomura suggest that while the oil price has been rising, implied vol has fallen recently as the 3m implied vol of the oil price has approached the historic low of 2014 and is consistent with the shift in the shape of the forward curve, which has moved into backwardation recently.
“Over the past three months, near-term oil price expectations have improved, in part due to expectations of an extension of the OPEC production cuts and geopolitical concerns, but the mid- to long-term view on oil prices is largely unchanged. In other words, the market does not expect a big trend shift in oil prices, which is probably why the implied vol has remained low.”
“Historically, the sensitivity of CAD and NOK to oil price movements tends to be lower when the implied vol of the oil price is low. We estimate the sensitivity of G10 FX to oil price by the level of oil price implied vol, and when this is more than 1 standard deviation below average, CAD and NOK tend to react less to oil price swings. The sensitivity of SEK and AUD to oil prices also has a tendency to decline amid low implied vol of the oil price. In this regard, the recent decline in NOK and CAD sensitivity to the oil price appears unsurprising.”
“If OPEC delivers a major surprise and influences the market view on the medium-term oil price trajectory this Thursday, implied vol of the oil price could pick up. Then, oil prices could again become a stronger driver of G10 FX. However, a nine-month extension of production cuts may not surprise the market. In contrast, no agreement on an extension of the production cut may be a negative surprise, at least in the short term, but current production cuts are effective until end-March 2018 and the market is likely to anticipate an agreement being reached in the future. Thus, the market’s view on oil prices may not be altered significantly, even if oil prices are initially affected negatively. As such, we believe the FX reaction to a disappointing result on Thursday should be contained. Sensitivity analysis shows that the near-term reaction of G10 FX to oil price movements is likely to remain subdued for now.”