Bank of America Securities Warns of Overpriced US Election Risk Premia in FX Markets
Bank of America Securities has issued a cautionary note regarding the rich pricing of US election risk premia in the foreign exchange markets. While these risk premia are currently high, analysts at the US bank suggest that they may already be overvalued.
Key Points to Consider:
- Historically, most FX vols do not realize enough to recoup the implied volatility premium around the US election.
- Contained volatility could be a catalyst for the FX carry factor to perform well post-election.
- Significant risk premium is currently priced into the foreign exchange markets, particularly in Asian emerging markets.
Analysis of the Situation:
Bank of America Securities has observed that the median major FX pair has priced in a 108% premium relative to the average of 2016 and 2020. This is measured by the daily bounce in the 2-month implied volatility before the US election. However, EM Asia vols have not performed well in US elections since 2012, leading the bank to favor fading implied volatility.
In a benign election scenario, the bank predicts spot prices to remain within a 6.85-7.30 range. Strikes at similar levels are seen as offering attractive premiums to volatility sellers. As a result, Bank of America Securities views a short USD/CNH strangle as an appealing option to fade the rich volatility premia. The main risk to this view would be larger-than-expected fiscal stimulus in China causing significant USD/CNH swings.
Current Market Situation:
At 04:35 ET (08:35 GMT), USD/CNH was trading 0.5% lower at 7.0621.
For investors and traders in the foreign exchange markets, it is crucial to be aware of the potential risks and opportunities presented by the upcoming US election. Understanding the dynamics of implied volatility, risk premia, and market reactions can help in making informed decisions and managing portfolios effectively.