SGD vols likely to rise after MAS policy shift, says Credit Suisse

The MAS announced on Friday it would maintain the current width of its policy bands for the SGD nominal effective exchange rate (NEER), and continue to allow SGD to appreciate, albeit at a lower rate. Currently, the SGD NEER trades around 0.7% below the midpoint of the policy band, and expects the new pace of appreciation to be 1% to 2% per annum, versus about 3% previously, says Credit Suisse.

Whilst SGD vols have fallen in response to the MAS announcement, Credit Suisse analysts says investors should take the MAS’s recent acquiescence for greater NEER movement within the 6% trading band as a signal for a higher implied volatility structure in USDSGD.

They argue that the last several weeks mark the first instance that they have witnessed where the MAS has allowed the NEER to traverse the full width of the bands, from top to bottom, without affecting a policy easing.

As a result, the risk to SGD long positions when the NEER is at the top of the band is now higher than before, which could lead the market to take profits on SGD longs faster and more persistently whenever the NEER reaches the top of the band. “We expect the implied vol structure of USDSGD to shift higher than in the past, given the recent NEER price action and the latest policy decision,” says Puay Yeong Goh, an FX strategist at Credit Suisse, in an interview with EuromoneyFXNews. Historically the MAS has preferred to keep the NEER in the upper half of the band.

“One of the messages from the MAS is that policy flexibility is preferred right now,” says Paul Mackel, head of Asian currency research at HSBC. “Keeping the width of the band unchanged suggests the MAS permits greater currency volatility for the Sing NEER.”

What this means for the options market is that, once SGD approaches the top of the NEER band, USDSGD implied vols will be higher than their previous average of around 5%, according to Goh. Markets should price in the higher risk that USDSGD will rise a lot higher in risk-off market conditions, as MAS will let NEER hit the bottom of the permitted band. In the options market, the skew will also remain high as the buying of downside protection should also increase, thereby making out of the money USDSGD call volatility more expensive when NEER approaches the top of the bands.

While vols and risk reversals may be subject to fall during risk-on moves, particularly if positive policy developments emerge in the eurozone, markets should take heed of the MAS’s implied relaxation of exchange rate movements and price in a higher implied volatility structure than they previously had.