The Economist - USA (2019-11-23)

The EconomistNovember 23rd 2019 Finance & economics 69

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T

rade wars; talk of impeachment; the

spread of populist politicians and hung

parliaments across Europe. It is hardly sur-

prising that an index from Policy Uncer-

tainty, a geopolitical think-tank, puts glo-

bal economic uncertainty at its highest

since the gauge was created in 1997. By con-

trast, implied euro-dollar volatility is trad-

ing at its lowest since the single currency

was born in 1999 (see chart).

Derivative contracts indicate that inves-

tors think the currency pair, the most

traded asset on financial markets, at

$400trn annually, will move less than 6%

next year. On November 14th the volatility

implied by the cost of “call” and “put” op-

tions (contracts that grant the right to buy

or sell at a pre-agreed price at some future

date) fell below the levels of the serene days

before the financial crisis in 2007.

Why the disconnect? One explanation is

monetary policy on both sides of the Atlan-

tic. The Federal Reserve started to tighten

in 2013, tapering its quantitative-easing

programme and, from 2015, raising interest

rates. In July its first rate cut since 2008

marked a policy u-turn. Its chairman, Je-

rome Powell, cited global uncertainty as

the main reason. In September the Euro-

pean Central Bank (ecb) cut rates for the

fifth time over the same period, to -0.5%.

The two central banks’ differing mone-

tary-policy trajectories sent the dollar up—

and the euro down. As a result, a greenback

buys 22% more euros than in 2014. Now,

however, the two currencies have stopped

being dragged in opposite directions. Mar-

kets forecast no policy change from the ecb

in the next two years, and just one rate cut

from the Fed.

A second explanation is that no matter

how rocky geopolitics has become, the tur-

bulence pales into insignificance com-

pared with fears during Europe’s sover-

eign-debt crisis that the single currency

would break up. The various debt woes of

Cyprus, Greece, Ireland, Italy, Portugal and

Spain meant currency traders priced in

such risk. A survey by Sentix, a consultan-

cy, asking investors to provide an estimate

of the probability that a euro-zone member

would leave within 12 months exceeded

70% in July 2012. The potential of an ensu-

ing collapse in the euro caused implied vo-

latility to soar. More recently fears of con-

tagion from Brexit, and the possibility that

France would elect a populist president,

Marine Le Pen, did the same.

That nerves have been calmed can be

seen in the yield on Italy’s ten-year govern-

ment bonds. In 2011 it went above 7%; now

it sits around 1%. And despite electoral

shocks and deadlocks, a break-up of the

euro is not on the agenda. The Sentix sur-

vey reading is now 6%. But traders should

keep their guard up. As in the financial cri-

sis, even when markets seem calm, volatil-

ity may come roaring back. 7

Why currency traders are serene even

as Western politics gets messy

Euro-dollar volatility

Safe haven

Port in a storm

*Impliedpercentagechangein€/$inoneyear’stime †Percentageofinvestors

surveyedbySentixwhobelieveatleastonecountrywillleavetheeurowithina year

Sources:Bloomberg;EconomicPolicy

Uncertainty;DatastreamfromRefinitiv

Economic policy

uncertainty index

One-year implied €/$

volatility*

$ per€

Expectedchangeinpolicyrateintwoyears’time

Percentagepoints

Eurobreak-upindex†,%

1999 2005 10 15 19

0

100

200

300

400

0

5

10

15

20

2014 15 16 17 18 19

1.0

1.1

1.2

1.3

1.4

2009 11 13 15 17 19

-1.0

-0.5

0

0.5

1.0

1.5

Federal Reserve

European Central Bank

2012 13 14 15 16 17 18 19

0

20

40

60

80

poses to properties and businesses, usually

over the coming five or ten years.

On such a timescale the range of esti-

mates for the impact of global warming

should be quite narrow, says James McMa-

hon of Climate Service. To handle unpre-

dictable inputs, such as whether a city will

decide to build sea walls, climate-service

firms offer a range of scenarios.

One reason for the buying spree is that

acquirers want to apply climate analysis to

their own books. Four Twenty Seven re-

cently found that about a fifth of all local-

government debt rated by Moody’s in

America is exposed to high heat stress. Bor-

rowers’ creditworthiness will be affected

by climate-related costs such as air condi-

tioning, lower labour productivity and

lower agricultural output.

Another factor in the spree is a coming

surge of new clients for climate services.

Policymakers are gearing up to make finan-

cial institutions disclose the climate risks

they face. At a un summit in September

Mark Carney, the governor of the Bank of

England, argued for mandatory disclosure

of such risks to investors and regulators.

France already has such a law. Britain, Can-

ada and the eumay follow soon.

Many companies are unprepared. A re-

cent survey by hsbc found that about two-

fifths of companies were disclosing cli-

mate-related risks in line with the expect-

ed rules. A poll of signatories to the

Principles for Responsible Investing, a un-

supported group of investors with $90trn

under management, found similar gaps.

Rather than buying climate intelli-

gence, some companies are training their

own staff. Earlier this year AllianceBern-

stein, an American fund manager, sent 35

portfolio managers on a course on climate

risk at Columbia University. Columbia has

trained analysts from pension funds and

major banks, says Satyajit Bose, who teach-

es part of the course. Last year Wellington,

an asset manager, announced a tie-up with

Woods Hole Research Centre, a think-tank,

aimed at improving its climate analysis.

One problem for the nascent industry is

that many climate-service startups come

from Silicon Valley, where experimenta-

tion is prized. “It’s one thing to have a dis-

ruptive app, but it’s a problem when that

app is inaccurately predicting climate

risk,” says Jesse Keenan of Harvard Univer-

sity. In August the New York Timesreported

problems at One Concern, an earthquake-

and climate-analytics firm. Software up-

dates changed estimates for the cost of di-

sasters; its platform gave inaccurate data

on buildings’ structural integrity. Com-

pany leaders said that product iteration

was common in Silicon Valley and helped

customers. But more such stories and the

industry’s credibility could suffer, slowing

a shift towards data-driven preparation for

climate change that is already overdue. 7