Let me put introduce areas of great concern that markets acknowledge but do not price for as they are too difficult to weigh. The Chinese/U.S. trade negotiations are simple relative to the potential impact from Turkey, Venezuela, Europe, and, of course the final decision on Brexit.
Before we address the potential prairie fires let’s revisit the IMF meetings and last week’s ultimate question. The IMF communique typically has some nuggets of nuance for policy. However, the recent statement is so innocuous that it renders itself irrelevant. They don’t even try to say that they are opposed to currency intervention or manipulation for domestic purposes.
Then there was question has been dogging investors: “What is the Fed afraid of?” The answer is well-hidden but the FED and all central banks are afraid of themselves. QE policy and ongoing dovish rhetoric has created a financial system that is reliant on cheap debt. The continuous interventions from the ECB, BOJ and the FED has moved investors to become massive sellers of volatility strategies in an effort to garner extra return. Before, it was the RISK PARITY trades that posed a threat if the stocks and bonds both sold off in tandem.
Now, insurance groups, pension providers and large investors have become actors in the search for higher yields. As Bill Gross proclaimed in Barron’s in 2018, selling “higher volatility in markets present opportunity to earn higher returns by selling volatility not cash bonds.” The more comfort that the FED provides to the market the greater the amount of SHORT VOLATILITY plays. This amount has risen to extreme levels. So the FED has been trapped by its own largesse.
If the FED were really initiating aggressive monetary tightening it would lead to the unwind of short volatility plays and might be a far greater systemic risk than many of the present models predict. So why the quick pivot by Powell? The huge amount of short vol on the books of the global systemically important institutions (G-SIBs) must keep the Fed chairman on the edge of his seat.
Tags: BOJ, Brexit, central banks, ECB, Fed, France, German, IMF
April 14, 2019 at 3:18 pm |
Yra,
Who then are the global systemically unimportant institutions that are the buyers of volatility? Size involved means a sober risk manager marks their BS and investors accept benchmark underperformance?
April 14, 2019 at 3:59 pm |
NW windwatcher—absolutely as the vol buyers get decayed and as you point out correctly—they underperform —I am been involved in funds where people get pissed and leave because of the under performance but I appreciate that strategy and never complain about returns that are well under the general market —insurance anyone???
April 14, 2019 at 5:16 pm |
Yet, here we find ourselves nearing record levels on three of our majors.
Well, it’s not as though we didn’t get a glimpse of the movie after last falls ominous trailer.
As always, thanks for doing the “work”.
April 14, 2019 at 5:58 pm |
Movies and trailers. Kind of like tornadoes and mobile home parks, one attracts the other. Kind of like Germans and Frenchmen, always allies!
Thank you Yra for the continued good work.
April 14, 2019 at 6:46 pm |
What are the Fed and Powell afraid of? Answer- Deflation. What has that institution done in the last decade regarding Glass Steagall and the Volcker Rule? Chipping away at safeguards while at the same time growing debt to keep the world economy above water is not a prescription for making one feel safe. When it takes four dollars of debt to increase GDP one dollar, and more debt is your main weapon, one can only repeat Paul Volcker assessment that we are in a mess. How do we get out of this mess? I don’t know anyone who has the answer. But the answer certainly isn’t that when you’re in a hole you keep digging.
April 22, 2019 at 12:42 pm |
“the FED has been trapped by its own largesse.”
Where and how deeply, will the survivors be buried?