Beware Of Volatility Blowback
BMI View: Despite efforts by the European Central Bank to quash volatility in the eurozone by eradicating left tail risk (there is now surprisingly little talk of a euro breakup) we warn of the possibility of a major blowback in 2014. We keep coming back to same fundamental constraint facing the euro area: a lack of serious structural reform of the currency union. Progress on a combined banking, fiscal and political union, as well as efforts to bolster internal and external competitiveness, has been minimal and suggests that the ECBs anaesthetic could abruptly wear off.
The eurozone in 2013 is a markedly different place to the eurozone of 2012. The breakout in financial market turmoil last year, underpinned by speculation of the euro area disintegrating, has given way to a period of relative bond market stability alongside stagnant economic growth. We have euphemistically referred to this transition as the eurozone crisis shifting from an acute to more chronic phase. Talk of the eurozone breaking apart has died down leaving a dearth of volatility and a more optimistic narrative. However, we view this newfound optimism in the markets as somewhat misplaced.
While we believe that policymakers have successfully defused near-term risks, we come back to the same constraint: a lack of serious structural reform. Without a fundamental overhaul of the euro area to tackle the internal and external competitiveness deficit, as well as progress on implementing the final stage of monetary union to satisfy all primary conditions of an optimal currency area (namely full banking, fiscal and political integration), the crisis can only ever be put on the backburner. With this in mind, we believe that volatility is cheap, which opens up opportunities on the long side for VSTOXX futures, as well as there being scope for some bearish sovereign credit positions. Below we take a closer look at what is pinning down volatility, possible reversal triggers and potential volatility and sovereign credit plays heading into 2014. In the case of the latter, we highlight in particular French and German bonds, which we have long believed would eventually be ripe for a bearish position.
|All Calm On The Western Front|
|Eurozone - VSTOXX Index & EUROSTOXX Volume|