The Norgesbank and PBOC
Both added fresh liquidity
But Madame Lagarde
Left her markets scarred
Thus failing quite staggeringly

Central banks around the world decided that they needed to act, and act they did. At least most of them. Since the ECB meeting yesterday, which was described as broadly disappointing, despite a commitment to increase QE by an additional €120 billion and a resurrection of TLTRO loans with bank borrowing costs set at the base rate -0.25%, we have seen at least six major central banks announce new plans led by our very own Federal Reserve. A quick recap of their activities shows the following:

• Federal Reserve – $5 TRILLION of funding through a promised ten $500 billion term repo operations over the next month as well as extending the current T-bill purchases into coupons (otherwise known as QE).
• PBOC – 100bp reduction of RRR for banking sector releasing $79 billion of reserves into the economy thus offering reduced cost funding to banks
• RBA – injection of A$8.8 billion into repo market to help ease funding pressures. (Remember, Australia is much smaller, so smaller numbers have big impact)
• Norgesbank – cut policy rate 0.50% in an emergency meeting
• Riksbank – injection of SEK500 billion ($51 billion) into banking system to help support economy and lending
• BOJ – offered ¥2.2 trillion of liquidity via repos as well as buying ¥101.4 billion in ETF’s and ¥500 billion of JGB’s in 5yr-10-yr bucket

So, the central bank community is not fiddling while Rome was burning, but yesterday it certainly wasn’t enough to stop the bleeding. You are all aware of the remarkable declines seen in equity markets yesterday, so I don’t need to repeat them. Rather, the one thing I want to highlight is the market’s evolving view of the Fed’s power. Remember, for the past 11+ years, the Fed and its brethren central banks have ruled the markets. When they moved, markets responded as desired. So, rate cuts led to equity rallies. And when the market screamed for relief, they came to the rescue and the market was calmed.

But yesterday, the Fed jumped in with both feet, promising an extraordinary amount of liquidity to the market and yet the result was historic losses in the stock market. The law of diminishing returns had been starting to assert itself of late, but perhaps yesterday was the last straw. After a very brief rebound of nearly 7%, the DJIA turned around and lost all of that and more by the end of the session. So, despite unprecedented central bank support, markets cratered. That cannot bode well for their future activities.

Now this morning, after all those other central banks joined the fray, markets have calmed a great deal with European equity markets massively in the green trying to recoup yesterday’s losses while US futures are also pointing much higher with all of them up by 5.0% as I type. Meanwhile, Treasury yields have reversed course and are higher, as today’s risk barometer is clearly ‘on’.

The one constant theme we have seen for the past weeks has been a significant increase in market volatility. In equity markets, the widely followed VIX has traded up as high as 76.8, a level only surpassed during the depths of the financial crisis in Q4 2008. At the same time, bond market volatility is often described by the MOVE index, which is currently at 152.6 also its second highest level ever. (The MOVE index was designed to mimic the VIX as a weighted average of 1mo options on a range of Treasury securities along the yield curve.)

And finally, FX volatility has exploded higher as well. Of course, the interesting thing about FX vols is even though they are much higher than we have seen recently, in many currencies they have just returned to long term historic averages. Since the financial crisis, as central banks around the world have anesthetized markets via constant increases in liquidity, market volatility has been in secular decline. And while recent price activity has certainly been choppy, it is not remotely unprecedented. Even in emerging markets. For example, looking at the euro, 1mo implied vol is currently around 9.7, which while the highest since the Eurozone debt crisis in 2015, remains far below the GFC highs of 23.6 and is right at the average volatility since the euro’s beginning in 1999.

In USDJPY, we have seen quite a bit more movement in spot as I’ve discussed recently, and implied vol in the 1mo is currently 17.6. That is certainly high, but not as high as we saw during the GFC nor during the Asian crisis in 1998. Meanwhile, cable vol at 10.75 in the 1mo is lower than we saw during the Brexit vote and far lower than during the GFC. My point is that while relatively unusual recently, currency markets have a long and glorious history of significant movement. And there is nothing to suggest that this is going to slow down in the near term.

This is the important feature because managing a hedge program during volatile markets can be a difficult task. While balance sheet programs tend to work well enough as they are focused on short-term FX swaps, the most robust part of the market, cash flow programs need to be handled more carefully. I remain a strong believer in the benefits of utilizing orders to execute spot transactions rather than chasing prices. In addition, given the historic nature of some of these moves, being willing and able to adjust a program to take advantage of an unusual market condition is something that separates the best hedging programs from the rest. As an example, the significant increase in the price the market is currently willing to pay for JPY calls vs. JPY puts combined with the still substantial carry available leads to zero-premium JPY collars for JPY receivables hedgers looking increasingly attractive, especially going out in time.

In the end, markets remain on tenterhooks as the ultimate impact of Covid-19 on the economy is completely unknown with many different opinions. History has shown that the spread of the virus will slow down at some point, but until then, the tension for governments between avoiding massive contagion and preventing the economy from crashing will continue to be driving commentary and official actions which will each have a market impact. While caution is reasonable, do not stop a hedging program because market conditions are difficult. Moderate the amounts you hedge perhaps but stay the course.

Good luck and good weekend