Since news of coronavirus first spread, markets have struck a decisively risk-off tone with higher yielding currencies selling-off. Commodity currencies and Asian markets have been particularly hard hit. Despite the fresh bout of FX weakness, implied vol has been relatively less reactive compared to other asset classes. As the top-left chart shows, the VIX has surged in recent weeks while FX vol has pushed only marginally higher.

Markets have become relatively more optimistic on US-China trade negotiations, immediate hard-Brexit risks have been defused and the economic data has stabilised in the euro area. While coronavirus is the latest flashpoint to spook markets, so far the fear of the virus far exceeds the economic impacts. However, given that Brexit and US-China trade issues remain unresolved, coronavirus could yet develop into a more serious outbreak and with the global economy beset with structural fragilities (rising inequality, weak income growth, the spread of populism etc), current FX vol levels remain attractive for hedging left-tail risks, in addition to long-dated puts on the BKLN leveraged loan ETF we have previously highlighted.

Source: Bloomberg, Macrobond and Variant Perception