BofA Sees Opportunity in Selective Currency Volatility Plays
Bank of America advises investors to focus on specific currency pairs rather than buying broad foreign exchange volatility ahead of potential Federal Reserve rate hikes.
According to BofA's analysis, implied volatility tends to rise selectively in certain currency pairs during the 21 business days before a rate hike and five business days after. The bank found that realized volatility has been more mixed across the G10 currency universe.
The bank identified three conditions for choosing volatility trades around potential Fed hikes: implied volatility should not have moved too far already, the currency pair should have historically shown realized volatility sensitivity around hiking events, and the connection between interest rates and the exchange rate should be clear.
Japanese yen crosses remain candidates for long volatility positions due to their sensitivity to funding conditions and interest rates. British pound pairs also appear attractive, as both implied and realized volatility have risen in past hiking events across major pound crosses, supporting a long volatility position in sterling ahead of the next Federal Open Market Committee meeting.