Notes From Underground: Prairie Fires On the Global Landscape

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.

***The theme of German/French animosity is gaining traction. It’s even the theme of Wolfgang Munchau’s piece in Monday’s print edition of the Financial Times. The French president’s intransigence on Brexit “caught most German political observers off-guard. Some members of Angela Merkel’s entourage in Brussels expressed unbridled fury at Macron’s insurrection. How dare he?”
NOTES FROM UNDERGROUND has been on this issue for many months as the concern is over the financial impact from a serious German/French blow-up. Even the great Europhile Munchau acknowledges that French has great exposure to Italy and its heavy debt load.This issue is critical for the global financial markets because of the fragility of the EU banking system. Pay close attention. Trade the trends but invest with great caution.

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6 Responses to “Notes From Underground: Prairie Fires On the Global Landscape”

  1. nwwindwatcher Says:

    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?

    • yraharris Says:

      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???

  2. Don H Says:

    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”.

  3. kevinwaspi Says:

    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.

  4. Asherz Says:

    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.

  5. Chicken Says:

    “the FED has been trapped by its own largesse.”

    Where and how deeply, will the survivors be buried?

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