Back on track

Volatility reared up sharply at the end of February. By March 8, one-month at-the-money implied volatility had leapt to 36.6% for the Hang Seng China Enterprise Index, 21.2% for the Nikkei 225, 23.1% for the MSCI Singapore and 30.3% for the S&P CNX Nifty, according to Deutsche Bank figures.

As equities tumbled, there was also a rapid widening of credit spreads (the iTraxx Asia ex-Japan Series 6 five-year index widened from 37 basis points on January 22 to 42bp on March 7), a rise in Japanese interest rates (from 0.25% to 0.5% on February 21) and a sharp appreciation of the yen (from Yen121.41 on February 21 to Yen115.15 on March 4). All this sparked fears of major losses in equity and credit markets, and big trouble for investors deploying the yen carry trade.

But as our article Carry concerns (pages 34-35) explains, the unwinding of carry trades proved to be a temporary measure - indeed, the yen weakened later in March. And it was a similar story in the credit market, with the iTraxx Asia ex-Japan index narrowing to 35bp by March 28. Indeed, investors have little current interest in taking positions where they expect the spreads to correct sharply in the near term (Steepeners: no great catch, pages 36-38).

Meanwhile, the wobble in equities, sparked by concern about the health of the US sub-prime mortgage sector, caused little more than a minor irritation - there didn't appear to be any 'blood on the Street', to use the trader's expression. This was partly because the market-retracing was far less pronounced than in May and June last year. But it may also reflect that a number of investors had learnt their lesson from last year and put on hedges to cover their long exposures to stocks.

As the excitement died down, attention turned to a couple of interesting new developments in the derivatives markets. The first concerned the debate about whether Asia's vibrant real estate market needs a new property price hedging tool (Laying the foundations, pages 18-21). The other centred on the significance of South Korea's first inflation-linked bond issue on March 23. This was the first of four 675 billion won ($720 million) linker issues planned this year. And the move may help ignite an inflation swap market in the region (see pages 14-17).

While some argue the launch of linkers will mainly benefit a small number of major dealers with the expertise to trade exotic inflation instruments, others say it points to the growing maturity of Asian markets. If the region realistically expects to de-couple itself from US consumption, this may represent an early first step.