Financial markets are clear as mud regarding geopolitical event risk. The relationship among the dollar basket, implied volatility ahead and overnight index swaps provides insight into a creeping conundrum for investors.
On one side, investors have taken an increasingly sanguine view of events. Volatility in foreign exchange markets has eased as the dollar has depreciated, which implies that global investors think geopolitical risk is fading despite rising oil prices and likely shortages in refined products.
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The dollar index has moved lower on an almost one-to-one basis with an easing in one-month-ahead volatility.
But the relationship between the dollar index and forward looking overnight index swaps is telling a different story, as investors are anticipating rising rates because of a sustained increase in inflation.
The takeaway
Both event and headline risk continue to proliferate yet one can plainly observe a disconnect between the surging equity markets and easing volatility in foreign exchange markets, and the increased risk being priced into the forward rate markets.
