An article published in Der Spiegel on Monday is causing quite a stir for its suggestion of a policy about-face by Germany. Angela Merkel and Wolfgang Schäuble have been viewed since the banking crisis began as inflexible and uninformed for their pursuit of fiscal austerity in the face of a balance-sheet recession. Now, it looks like domestic political heat may be causing the German fiscal ice to thaw.
To come to grips with the problem, Merkel and Schäuble are willing to abandon ironclad tenets of their current bailout philosophy. In the future, they intend to provide direct assistance to select crisis-ridden countries instead of waiting for other countries to join in or for the European Commission to take the lead. To do so, they are even willing to send more money from Germany to the troubled regions and incorporate new guarantees into the federal budget. ‘We want to show that we’re not just the world’s best savers,’ says a Schäuble confidant.
French and German ministers are also set to unveil a “new deal” on Tuesday designed to address the widespread problem of youth unemployment. The plan would use funds from the European Investment Bank to help small and medium businesses hire workers and to encourage apprenticeships.
Let’s get a snapshot of Euro STOXX 50 volatility to inform our trading. First, notice that the one month implied volatility of both SX5E and SPX options is ranked at about 6% versus the last five years. The headlines this year have been all about U.S. equities making new highs, but the volatility bid on eurozone equity indexes has been falling as well.
SX5E & SPX 1-Mth IV %-ile rank (5Y). Source: STOXX, CBOE, Condor Options
The following chart shows the slope of SX5E option implied vol at ten and two month horizons, i.e. how expensive it is to roll a long volatility position. A high (low) value indicates a contangoed (backwardated) term structure. The low of 0.80 in August 2011 corresponds to the period with the worst outlook for eurozone unity; the highest levels here came in late 2012, before weakening data and the Cyprus saga unnerved some people.
VSTOXX 10-Mth / 2-Mth Slope. Source: STOXX, Condor Options
The term structure on this estimate is only slightly above the median value since 2010. If these new fiscal policies boost demand in southern Europe, we could see VSTOXX contango push to new highs.