IS THE RISK really fading out??? Be cautious!!!

The Exclusive Article Prepared By the India Forex Advisors Research Team on the risk rally seen in the global markets. 

“A lot of confusion is there as where these markets are heading towards. The volatility in the global markets is at its highest levels.

These days, many indicators suggest that we are in an extremely low-risk market environment. Investors should take caution from the latest development as the important point is that the price of risk can sometimes stray from fundamentals.

The Chicago Board Options Exchange Volatility Index, or VIX, sometimes known as the fear index, has reached a five-year low. The Volatility Index, which shows the market's expectation of 30-day volatility, is constructed using the implied volatilities of a wide range of S&P 500 index options. This volatility is meant to be forward looking and is calculated from both calls and puts. The VIX values above 30 typically reflect great volatility, while values below 20 reflect calmer markets.

The global Stocks have been rallying relentlessly to post-crisis highs. Meanwhile, the volatility index is near historic lows. In today's world, the meagre level of the VIX and record low yields on credit-market, instruments are largely linked to the Federal Reserve's accommodative monetary policy, which is artificially damping the market risk.

Some option traders have made an enormous $11.25 million bet that the VIX will explode higher very soon. And according to them the rally in the VIX is usually accompanied by a drop in the stock markets.

In January 2007, with the housing bubble at absurd proportions (home price-to-rent ratios reached levels never seen before) the VIX closed at less than 10, the lowest since December 1993. It took 18 months, but ultimately stock markets buckled and the VIX surged to 80 as credit risk and mortgage securities underwent a wrenching global reprising.

In the US, the 10 year Treasury yield is trading below 2%. Artificially low Treasury yields also satisfy the policy makers who fail to act with urgency in tackling the US debt problem. There was a time when US treasury was seen as a safe haven at the time of crisis or uncertainty in the markets. The treasury yields inching down reflected the risk aversion in the global markets. But now it seems there is nothing safe about treasury yields in the today's context looking at the frightening debt dynamics in the US.

To smartness, for deficit and unemployment reduction all assume that the interest rates will be kept exceptionally low by FED into the future as well. This is an unwise assumption to make. We can't keep interest rates artificially low to stimulate the economy because it's the low interest rates that are the source of the problem. And the recent talks of ending the asset purchase in the FOMC meet also points out the view of FED officials to turn the curve of the low interest rate.

As noted, QE2 did less to push down interest rates than the first round of QE, and QE3 is doing even less than QE2. To some extent this is necessarily because rates can't go much lower.

Although the Fed seems determined to continue it for some more time, one must wonder what might happen to riskier assets if Treasury yields jump. One must question, if the Fed's campaign to suppress interest rates is supporting a dangerous build up of government debt at prices that are detached from the true risk profile???”

(Source: Corporate Communications, India Forex Advisors Pvt Ltd)