Implied volatility in emerging market currencies - a gauge of expected swings in their exchange rates - rocketed to multi-month highs on Monday, fuelled by massive price falls in commodity and credit markets. One-month implied volatility derived from options prices has spiked on the Turkish lira, Indonesian rupiah and Brazilian real among other currencies.
Volatility has spiked right across the asset classes, ranging from Wall Street's favourite fear gauge of US blue chip volatility to euro/dollar rates to US high-yielding bonds.
Oil's price collapse to around $60 a barrel has seen spreads on high-yield bonds from US energy companies balloon to 771 basis points over Treasuries, almost doubling from the levels at the end of August and fanning fears of a spike in defaults.
But to the extent that a spike in financial price gyrations is a measure of rising risk, it always hits higher-yielding, higher-risk assets hardest - often by forcing an unwinding of speculative high interest rate plays funded in cheap hard currency borrowings. This often ends in a spiral of selling.
Monday was a prime example of this, with emerging market currencies selling off across the board. The rupiah hit its lowest since 1998 and the rouble saw its biggest one-day fall since Russia's crisis that same year. The losses filtered into options markets, as investors rushed to hedge against further losses.
"Fundamentally, we are of the view that currencies are the weakest link in emerging markets," said Bhanu Baweja, head of global EM strategy at UBS.
"Commodity prices are now exerting pressure on credit and that's pushing up volatility on markets in general...This is a much belated come-uppance of EM currency vols," he added.
The rouble led the way, with one-month vols at almost 50 percent, having risen steadily since autumn while lira one-month vols leapt to almost 12 percent, the highest since March and Brazilian real vols were at one-month highs.
Rupiah vols were also at 12 percent, posting the biggest one-day rise since mid-2013 when emerging markets were in the throes of a mini-selloff.
Low pre-Christmas liquidity is also taking a toll, Citi analysts noted, predicting more falls in emerging currencies.
"The natural lack of liquidity ahead of the holiday weeks is an important additional layer of complexity in this story," they told clients, adding: "Risk is not responding positively to further legs down in oil prices anymore."
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