Currency Volatility Declines as Subprime Credit Concerns Wane

Volatility on currency options fell further from the eight-year high touched this month as concern eases that a U.S. housing slump is spreading.

JPMorgan Chase & Co.'s index of implied volatility on options for the most-traded currencies fell to 8.19 percent yesterday, down from 8.32 percent at the close of last week, and down 5.21 percentage points from 13.4 percent on Aug. 17, the highest since 1999. Implied volatility, a gauge of traders' expectations for future price swings on currencies, is a component of option prices.

The Federal Reserve cut by a half a percentage point on Aug. 17 the rate it charges banks borrow, to 5.75 percent, in an attempt to avert a credit crunch and restore investor confidence. Rising delinquencies on subprime mortgages forced two hedge funds managed by New York-based Bear Stearns Cos. to file for bankruptcy in July and other funds, including BNP Paribas SA in France, to halt withdrawals.

``The central banks told the markets that they were going to be involved and that things were going to be ok,'' said Evan Steed, head of currency options at TD Securities Inc. in Toronto. ``The huge panic that we had seen seems to be alleviated.''

Implied volatility on one-month dollar-yen options was at 12.18 percent yesterday in New York, down from 23.5 percent on Aug. 17, the highest since January 1999. Swings in the exchange rate increased as the yen rallied after investors, exiting prior bets the yen would fall, drove the currency to a 14-month high of 111.61 per U.S. dollar on Aug. 17. It traded at 115.87 per U.S. dollar yesterday.

U.S. Treasury three-month bills yields rose 25 basis points, or 0.25 percentage point, yesterday to 4.47 percent. On Aug. 20 they touched 2.505 percent, the lowest since February 2005 as investors sought the safety of government debt.

Volatility Decline Temporary

Sales of previously owned homes in the U.S. in July declined 0.2 percent, less than forecast, to an annual rate of 5.75 million, from 5.76 million in June, the National Association of Realtors said yesterday. New home sales unexpectedly rose in July for the second time this year, to an annual pace of 870,000, the Commerce Department said Aug. 24.

The decline in currency volatility may be temporary, until after the Sept. 1 Labor Day holiday, according to Tim Graf, derivatives strategist at Credit Suisse Holdings in New York.

``The subprime related credit issues are far from over,'' said Graf. ``For the next year or two, volatility should stay fairly elevated as people won't take risk for granted anymore. Actual volatility in the underlying currencies will stay high.''

A reduced certainty on the direction of interest rate changes by major central banks may increase swings in currencies.

ECB President Steps Back

European Central Bank President Jean- Claude Trichet stepped back yesterday from his earlier signal that interest rates will be increased next week, saying policy makers plan to wait before deciding whether financial market turbulence is hurting economic growth.

In his first public appearance since the market rout began, Trichet said in Budapest that the bank was not ``pre-committed'' to raising borrowing costs on Sept. 6. He avoided repeating his Aug. 2 statement that the ECB was monitoring inflation with ``strong vigilance,'' a phrase used to foreshadow previous rate increases.

``No-one can say with any certainty what any of these central banks will do,'' said Graf. ``This will provide volatility to the currency markets in the months ahead.''

Fed funds futures contracts yesterday showed traders see a 28 percent chance the Fed will lower its target for overnight bank lending to 4.75 percent from 5.25 percent at its next meeting on Sept. 18, down from 42 percent odds on Aug. 24.