What are Risk Reversals Saying about EUR/USD?
July 16, 2008
Risk reverals in the EUR/USD have hit an extreme level. The 25 delta 3 month risk reversals are at the highest level since June 2007. Whenever risk reversals hits critical levels, it indicates that everyone who wants to be long euros are already long and as a result, sentiment has hit an extreme.
The last time EUR/USD risk reversals came near current levels was in June and September 2007. Both times, we saw a relief rally in the US dollar that lasted for approximately 250 to 300 pips. This time around, risk reversals are once again telling us that the US dollar has become oversold and is due for a further rally. But like in June and September, the long term downtrend in the dollar is intact.
Source: Bloomberg
Will the Fed Intervene to Prop Up the Dollar?
The dollar is also rallying because this morning, Bernanke said that forex intervention should be done rarely and that USD intervention may be justified in disorderly times. Most of us would argue that current conditions can be described as “disorderly.”
But intervention would not accomplish much as this point. The main reason for intervention in the dollar would be curb inflationary pressures and inflation expectations. Even though CPI hit the highest level in 17 years on an annualized basis, oil prices have fallen $13. A steeper decline would naturally curb inflation expectations. The only other reason for intervention would be to restore investor confidence in the US equity markets.
Risk reversals measure the difference in volatility between similar (in expiration and relative strike levels) FX calls and put options. The measurement is calculated by finding the difference between the implied volatility of a call with a 25 Delta and a put with a 25 Delta.
Posted in Bernanke, dollar intervention, forex blog, risk reversals eurusd
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July 17th, 2008 at 10:17 am
[...] as the Euro, British pound and Australian dollars. A further recovery could be possible given the extreme levels of EUR/USD risk reversals, but traders should do as the Sovereign Wealth Funds do by looking for opportunities to sell rather [...]
July 20th, 2008 at 5:14 pm
Look, it is collapsing now. It is down over 40% vs. the Euro and will go lower. We are watching the American Empire come unglued. The idiots who thought America would never have to make anything again were all wrong. No nation can run a 700 billion dollar trade deficit and have a sound currency. Not even America. Our Trade policies since 1974 have been all wrong. Wrong for the country, wrong for the currency , wrong for the workers. We are in one hell of a mess now.