Evergreen advice here from Citi:
Beware of unexpected outcomes to expected events.
But it’s the accompanying chart that’s worth the click: Read more
Following up on our volatility has actually been falling post, here’s Alan Ruskin of Deutsche Bank:
The reaction in riskier assets to the recent sell-off in G10 sovereign bonds remains informative. In the relatively illiquid US high yield market, spreads have come in over the past week. Equities have seen some pick-up in volatility, but the VIX at sub 14 is very low relative bond/swaption vol. Gold vol is going nowhere. EM FX would seem to have been very vulnerable O/N and instead most the FX price action seemed to reflect moderate positioning adjustments consistent with limited s/t EM carry exposure, outside the INR. The upshot is most other markets trade with some confidence that the G10 sovereign bond sell-off will not get out of hand.
With the German 10 year bund yield closing higher in 14 of the last 16 sessions, a concentrated pocket of volatility can still be painful for those involved. The outstanding question remains whether sovereign bond market noise is technical and temporary, or the distant but distinct clanging of an alarm. Read more
It may not feel like it on Thursday, as bond yields rise, but a timely piece on cross asset volatility strategy from JP Morgan notes overall volatility was down in April.
The interest rate volatility shock of the past few weeks did not lead to a generalized rise in volatility. In fact implied volatilities exhibited a rather mixed pattern over the past month with euro swap rate volatility rising sharply in the 30y sector but declining on the month in the 10y sector, with Eurostoxx50 volatility rising but S&P500 and Nikkei volatility falling instead, and with credit volatility rising in Europe but falling in the US.
More below, but lets cut to the main point: the unwinding of trades based around European quantitative easing over the past two weeks has been “rather technical and thus likely to be short lived”. Buy on the dips etc, or keep selling vol. Read more
This volatility is to low
This volatility is too high
This volatility is … holy cow … the SNB just removed its currency floor?
Investors in the big trading banks are spending the week discovering that financial institutions are the Goldlilocks of the volatility world after the likes of JPMorgan, Goldman et al released some disappointing fourth-quarter earnings despite an uptick in vol. With banks having spent much of the past five years moaning that volatility was too low to eke out trading profits, it turns out that in the fourth-quarter volatility was just a bit too high to make money. Or not quite the right kind of volatility. Or whatever. Read more
In February 2012, Macro Risk Advisors drew our attention to an explosion in the market cap of the TVIX ETP, the 2x Vix exposure ETP offered to the market by Velocityshares, but backed by Credit Suisse.
As it happens, that fact turned out to be a perfect forward indicator to a whole sequence of shenanigans and suspensions to come in the ETP, confirming a general rule in our minds that whenever ETP market caps explode, beware, there’s probably someone somewhere (not the dumb money, of course) unearthing an arbitrage at the expense of the vanilla investor.
Well, more than two years later — perhaps because 2x Vix exposure isn’t quite as sellable as it used to be — the recent volatility spike has flamed another curious explosion in market cap. But not in volatility hedging instruments that reward when volatility spikes up, but rather, their exact opposite: inverse volatility ETPs, which reward when volatility reduces. Read more
From the Reserve Bank of Australia’s assistant governor, and eminent CampAV robot attendee, Guy Debelle in a speech on Tuesday:
When volatility returns, for a number of reasons, including those I have already mentioned, it may well rise quite rapidly. One thing I am sure of is that the spike in volatility will be blamed, rightly or wrongly, on regulation-induced reductions in market-making.
But if we look back at previous market sell-offs, when market-making capacity was larger, we see that they were often quite violent too. Market-makers can pull back in an environment of rapidly falling prices, either directly, or indirectly by significantly widening bid-offer spreads. Market makers generally have just as much reluctance to catch a falling knife as any other market participant. They are after all intermediators of risk, looking to lay it off quickly, rather than being a warehouser of risk.
On the search for lost vol, complex systems and the limits of analysis from HSBC:
A curious feature of current conditions is that the explanation for the phenomenon is often taken to be self-evident. It’s caused by QE and low interest rates. It’s caused by lower trading volumes from hedge funds. It’s caused by lower risk appetite (even though risk premia are highly compressed). It’s caused by crisis fatigue and complacency.
Or, a history of vol, courtesy of Goldman:
A counterpoint to worries about the stuffy air of silence settling on markets arrives from Citi. Fear not the market calm, it is an unreliable sign of things to come.
There is little relationship between market volatility and future equity returns over any time horizon. Current low levels should not be seen as a clear sign of investor complacency and an imminent market correction.
Pickers of stocks cannot relax, however, because while market level volatility is low, it turns out that “style volatility” is up. Read more
Here’s your risk adjusted returns for May, from Barclays:
Apparently the first May since 2009 that global equity markets managed a positive return too. Not that it was overly exciting, according to Barc no macro asset moved more than 1.5 standard deviations and measures of macro volatility remained near multi-year lows. Read more
From a tame taper to a rate rage? And on its birthday too.
As Alan Beattie says, it was a year ago this week that the “taper tantrum” shook emerging markets, after comments from Ben Bernanke raised fears of the Fed tightening monetary policy. That sucked for EMs even if the reaction to the actual taper, which began in December, was much more chilled.
But it’s what happens when rates eventually rise that’s perhaps more interesting now. From Lombard Street’s Dario Perkins (our emphasis): Read more
Here is how a (now very sad) institutional investor was positioned during this year’s rally in bonds, commodities and equities according to Michael Hartnett’s latest Thundering Word at BofAML:
Very simply portfolios were positioned, in an extreme way, for Higher Growth-Higher Yields-Higher Dollar, and that backdrop is yet to transpire (Portfolios were also positioned for sub-7% China GDP and that also didn’t happen). Investors long Small Cap, Tech & Banks and short Gold, Government Bonds and Emerging Markets have been hammered.
More to the point, says Hartnett, those reeling institutional investors have been rushing into cash as their performances suffered. That was helped in no small part by the rally in Treasuries: Read more
How quiet is too quiet?
A reaction we keep hearing to the fact that volatility has seeped out of a lot of markets is that comparative calm should be expected. The supportive actions of central banks fit with the encouragement to keep taking risk, at least for now, as the unconventional easing policies should persist for a while. Read more
Tim Hartford directs us to a nice piece by John Cassidy in the New Yorker this week wondering why it is that hedge funds can still get away with making a killing when their performance is so underwhelming these days.
It is, in his opinion, a bit of a mystery.
He adds that even though institutional money is putting pressure on fees — in some cases leading to the traditional 2 and 20 model being sliced to 1.4 and 17 — it’s hardly enough of a cut to justify the lackluster performance.
Furthermore, the biggest and most successful funds don’t seem to have this problem. Their ability to attract money on those terms suggests there’s no end of rich people happy to throw their money at them. Read more
Crowded trade alert.
Chris Cole, of volatility fund Artemis Capital, has an insightful piece in the latest edition of the CFA Institute Conference Proceedings Quarterly warning about one of the most popular trades of recent times: the shorting of volatility via Vix ETPs.
The speculative shorts on Vix futures as a percentage of open interest, for example, are already running at an all-time high. In Cole’s mind this now equates to the shoeshine boy trade of the modern era.
One of the ironies, he also notes, is that the trade simply synthesizes a much less efficient version of a 3-4 times leveraged position on the S&P 500. Read more
Remember the Great Moderation, those sunny days of fun and laughter before the Great Recession stomped into town and set fires everywhere? (Imagine if old Uncle Bernanke and his canasta partner Mr Monti didn’t have that hose handy..?)
Well, Goldman Sachs have taken a look at just how far memories have faded by the way that disaster risk is now priced. It may be that the US was singed first, but it is far more relaxed than Europe. The overall return to moderation, however, is not yet complete. Read more
Citi’s Hans Lorenzen is inciting a rebellion against central bank repression. Now more than ever, he suggests, is the time to fight the Fed.
First, he notes, realised volatility in credit is down almost 90 per cent from its peak two years ago, and spreads are now at 50-year lows. He blames this on central banks, which are “suppressing risk across markets”. Read more
The working theme at FT Alphaville towers is that we’re in somewhat of a damned if we do taper/suspend QE, and damned if we keep going with it.
What’s more, we now know that even the whiff of tapering — which is anything but an unwind, as we’ve noted here — can cause undue chaos in risk assets. In which case, perhaps tapering isn’t as much of an option as many believe it to be.
After all, QE reflects the sovereign put. It’s the government subsidy which takes volatility away. If you stop dishing it out, there’s every chance bad things may happen.
Before we comment about the strange behaviour of the Vix this week, we’d like to engage in a bit of a thought experiment.
There are two hypothetical scenarios that we’d like you to consider.
The first relates to the rampant nationalisation of everything:
What happens to market prices and volatility in an economy where government intervention becomes de rigeur every time prices misbehave?
Taken together, the policy vol crunch and regret factor must be putting the remaining bears in a paroxysm of remorseful fear.
He’s very quotable, Nomura’s Kevin Gaynor. Read more