Tag Archives: #VIX

End of Days

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The one thing about which we’re sure
Is risk assets lost their allure
It’s not clear quite yet
How big a reset
Is coming, and what we’ll endure


Now, I don’t think its end of days
And this could be quite a short phase
But don’t be surprised
If answers devised
Result in a lack of real praise

Chaos continues to reign in the markets as volatility across all asset classes has risen substantially.  Perhaps the best known indicator, the VIX, is back at levels seen last during the Covid pandemic.  Remember, the VIX is a compilation of the implied volatility of short-term equity options, 1mo – 3mo.  While markets can technically be volatile moving in either direction, the VIX has earned the sobriquet of ‘fear index’ as equity volatility most typically rises when stock markets fall.  As you can see from the below chart, the movement has not only been large, but very quick as well.

Source: finance.yahoo.com

The key thing to remember is that while volatility levels can rise very quickly, as the chart demonstrates, their retracement can take quite a long time to play out.  Part of that is that even when things start to calm down, many investors and traders are worried about getting burnt again, so prefer holding options to underlying cash positions.  At least until the time decay becomes too great.  My point is that look for trepidation amidst the trading community and markets in general for a while yet, even if by Friday, the tariff situation is made perfectly clear.  Of course, with that as background, we cannot be surprised that the Fear & Greed Index has made new lows.

Source: cnn.com

However, arguably of more concern is the price action in US Treasuries, which despite the havoc in the market, are not playing their historical safe haven role.  Instead, Treasury bond yields are rising, actually trading as high as 4.50% around midnight last night although they have since retraced a bit.  The bond market has a generic volatility index as well, the MOVE index, and it, too, is trading at very high levels, the highest since the GFC.

Source: finance.yahoo.com

In many ways, this is of much greater concern to markets, as well as both the Treasury and the Fed.  The 10-year US Treasury is the benchmark long-term rate for the entire world.  A rise in the MOVE index may indicate that there is something wrong with the bond market and its inner workings, or it may be an indication that inflation expectations are rising quickly.  Whatever the reason, you can be certain the Fed is watching this far more carefully than the VIX.

I have heard two explanations for the bond market’s recent performance as follows:  first, there are those who are saying that China is selling its Treasury bonds and using the dollar proceeds to buy gold.  Now, while their holdings have been slowly shrinking, they still have just under $800 billion, so that is a lot of paper and would clearly have an impact.  The thing about this thesis is we will be able to determine its reality when China next reports their reserve numbers next month.  

The other explanation rings truer to me and that is the bond basis trade may be unwinding.  Briefly, the bond basis trade is when investors, typically hedge funds, arbitrage the difference in price between cash Treasury bonds and Treasury bond futures on the exchange.  The current positioning is these funds are long cash and short futures, and since it is a basis trade, they typically lever it up significantly, with leverage ratios of up to 100x I understand.  The total size of this trade is estimated at > $1 trillion.  Now, if this arbitrage disappears, or these funds are forced to liquidate this strategy quickly, it could be a real problem for the Treasury market.  

Ever since the GFC and the Dodd-Frank legislative response, banks no longer carry large bond risk positions and are not able to absorb large transactions seamlessly.  During Covid, you may remember that Treasury yields were all over the map, crashing and then exploding higher one day to the next, and that was caused by this basis trade unwind.  Back then, the Fed purchased nearly $1.7 trillion in QE to stabilize the market, and by all accounts, the basis trade was half the size then that it is now.

Remember, too, arguably the most important part of the Fed’s mandate is to maintain Treasury bond market stability.  Without this, the US will not be able to fund its debt and deficits.  So, whatever your view of how Chairman Powell may respond to the tariff story, which seems to be patience for now, if the bond market starts to break, you can be sure the Fed will step in.  QT will reverse to QE in a heartbeat as they offset the impact of this position unwinding.  If that is the case, I anticipate we will see further weakness in equities and the dollar, while gold will truly shine both literally and figuratively.  I’m not saying this is what is going to happen, just that this explanation makes more sense to me.  

Ok, now that tariffs have officially kicked in as of midnight last night, let’s see how markets are responding this morning.  Most equity markets continue to struggle after yesterday’s disappointing US session, where higher opens eroded all day with the major indices all closing on their session lows.  This bled into Asia where Japan (-3.9%) gave up most of yesterday’s gains although both China (+1.0%) and Hong Kong (+0.7%) held up well amid government support.  As to the rest of the region, Taiwan (-5.8%) was worst off, but other than Thailand and the Philippines, both of which managed gains, every other index was lower, often sharply.  In Europe, the realization of the tariffs is hurting with declines of -3.0% to -4.0% across the board.  As to the US futures market, at this hour (7:25), all three major indices are lower by at least -1.0%.

Bond yields are all over the place this morning with Treasuries (+8bps) continuing their recent climb amid the fears discussed above.  However, in Europe, things are such that German yields (-1bp) are doing fine while UK Gilts (+9bps) are suffering along with Treasuries.  The rest of the continent, save the Netherlands, has also seen yields rise, but much less, between 2bps and 5bps.  Overnight, JGB yields were unchanged as players are uncertain as to the next steps by the BOJ there.

In the commodity market, oil (-5.6%) is once again under major pressure.  This feels like a confluence of both technical factors (the price has broken below long-term support at $60/bbl and is now testing for lows) and fundamental factors, with OPEC raising output and the mooted recession likely to reduce demand.  Interestingly, lower oil prices are a tremendous geopolitical weapon for the US as both Russia and Iran are entirely reliant on them for financing their activities.  As to the metals complex, gold as regained its luster (sorry 😁) rallying 2.8% and well above the $3000/oz level.  This has taken silver (+3.1%) and copper (+3.5%) along for the ride.  It seems to me the copper story is not in sync with the oil story as a recession would likely drive copper prices lower, but that is this morning’s movement.

Finally, the dollar is softer again this morning with the euro (+0.8%) trading through 1.10 and the yen (+1.0%) back below 145.00.  It’s interesting because there was a story last night about how the new Mr Yen, Atsushi Mimura, was speaking to the BOJ amid concerns that the yen has been too volatile.  However, to my eye the movement has been relatively sedate, strengthening gradually and still, as can be seen in the chart below, substantially weaker than for the many years prior to the Fed beginning to tighten policy in 2022.

Source: finance.yahoo.com

The other noteworthy move is CNY (+0.5%) which after slipping to levels not seen since 2007, has retraced somewhat.  If Treasury bonds are not seen as haven assets for now, the dollar has further to fall.

On the data front, the FOMC Minutes at 2:00pm are released, but given all that has happened since then, it is hard to get excited that we will learn very much new.  We also see EIA oil inventories with a modest build expected, but this market seems likely to have adjusted those numbers outside any forecasting error bars.

The tariff story will continue to drive markets for now as investors try to determine the best way to protect themselves until things settle down.  And things will settle down, but when that will happen is the $64 trillion question.  FWIW, which is probably not much, my sense is that we have a few more weeks of significant chop, as we await clarity on the tariff policy (meaning its goals).  I still believe there will be a number of deals that will reduce the initial numbers, but the ultimate goal is to isolate China.  It is going to be messy for a while yet.  As to the dollar through all this, my sense is lower, but not dramatically so.

Good luck

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Half-Crazed

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The rest of the world is amazed
And frankly, I think, somewhat dazed
The vote in the States
Deteriorates
Each cycle, as folks turn half-crazed
 
But still, everyone cannot wait
To find out if we will be great (again)
Or if we will turn
The page and thus spurn
The chance to encourage debate

 

By now, I imagine most of you have figured out my preference for the election outcome and whatever your view, I sincerely hope you don’t hold it against me.  However, if that is the case, so be it.  In the meantime, whatever happened in markets yesterday and overnight just doesn’t matter at all as the opportunity for a major revision of perceptions is so large as to make any price information completely useless, at least in the US markets.

I have seen numerous studies showing the history of how markets behave in presidential election cycles, but I think it is a fair assessment that the current cycle is unlike any previous cycle that we have seen since, perhaps, just before the Great Depression.  Simply consider the massive amount of information that is available to the average person from numerous sources these days compared to anytime in the past.  As such, I don’t put much faith in any of those studies.

Which takes us to this morning.  Do we truly have any idea what the outcome will be?  I would argue not although we all have our favored outcomes.  And that bias, I believe, is deeply embedded in virtually every analysis.  As such, I will not try to analyze.  Rather, I will observe.

The first observation is that market implied volatility has been rising for the past weeks as the seemingly dramatic differences in policy outcomes depending on the ultimate winner mean market dislocations in either direction are quite possible.  

For example, let’s look at 1-month implied volatility in the major USD currency pairs this year as per the below:

Source: Capital Edge Corner via X

They have been rising steadily since early October as a combination of corporate hedgers trying to protect themselves and hedge funds and traders trying to profit from the dislocation have increased demand steadily.  The one truism here is that upon confirmation of a winner, regardless of the underlying move in the dollar, implied volatility is going to decline.

Much has been made of the ‘Trump trade’ which appears to mean that if Trump wins, the prospects for higher growth and inflation will steepen the yield curve, driving yields higher, while supporting the dollar (much to Trump’s chagrin) as foreign investors flock to US equities.  In fact, the most common explanation for the dollar’s decline over the past several sessions has been that Harris has improved in the polls.  

But it is not just the FX markets where implied volatility is rising, look at the VIX below, which is also showing a steady climb over the past two months.

Source: Fred.gov

That spike in August was the almost forgotten market response to the BOJ tightening policy and the -12% decline in the Nikkei just days after the Fed didn’t cut interest rates as many had hoped.  But if you eliminate that event, the trend higher remains intact.

Finally, the MOVE Index, which is the bond market volatility index shows very similar behavior, a steady climb over the past month especially, but truly trending higher since the summer as seen below:

Source: Yahoo Finance

My point is that given the growing uncertainty across all markets as well as the complete inability to, ex ante, determine who is going to win the election, the signal to noise ratio of price movement right now is approximately 100% noise, at least in financial markets.  Commodity markets have a bit of a life away from the election, so price action there is far more representative of true supply and demand issues.  Arguably, this is merely another consequence of the financialization of most things, the loss of market signals as they have been overwhelmed by the flood of liquidity provided by central banks around the world.

At any rate, until we know who wins, it will be difficult to establish a view of the near-term or long-term future of market activity. So, let’s recap the overnight session as its all we have left.

After yesterday’s equity selloff in the US, most Asian exchanges posted gains led by China (+2.5%) and Hong Kong (+2.1%) which responded to comments from Chinese Premier Li Qiang’s comments that, “The Chinese government has the ability to drive sustained economic improvement.”  And perhaps they do, although there are clearly issues regarding the local entities that are willing to gain at the expense of each other in order to demonstrate their own progress.  But Japanese shares (+1.1%) also rallied along with most of the region, perhaps a direct analogy to the US decline as the ‘Trump trade’ has included weakness in markets likely subject to Trump’s promised tariffs.  Meanwhile, in Europe, bourses have edged slightly higher this morning, between 0.1% and 0.2%, with no new data or news of note.  Interestingly, US futures are starting to trade higher at this hour (6:50), perhaps an indication of market beliefs, although just as likely part of the random walk down Wall Street.

In the bond market, Treasury yields (+3bps) are creeping higher again, also in line with the Trump trade, and that seems to be dragging European sovereign yields along for the ride as all those markets have seen yields climb between 4bps and 5bps.  Again, given the lack of new data, and the history of these yields following Treasuries, I see no other strong explanation. 

In the commodity markets, oil (+0.3%) continues its rebound and has now gained more than 6.5% in the past week.  The combination of OPEC+ delaying their planned production increases and seeming hopes for a pickup in Chinese demand on the back of the coming details of the stimulus package seems to have traders in a better mood these days.  As to the metals markets, they are all firmer this morning with gold (+0.2%) mostly biding its time ahead of the election, but both silver (+0.8%) and copper (+0.9%) starting to accelerate a bit.  Nothing has changed my view that regardless of the election outcome, this space is far more dependent on continued central bank policy easing and there is no indication that is going to end soon.

Finally, the dollar is softer again this morning, but in a more muted fashion than the past several sessions.  Although, with that in mind, we still see the euro and pound both climbing a further 0.25% and AUD (+0.6%) today’s leader after the RBA left rates on hold with a more hawkish statement than anticipated.  But the weakness is widespread with NOK (+0.4%) continuing to benefit from oil’s rise while ZAR (+0.6%) gains on the back of the rise in metals.  Of course, the currency that has seen the most discussion ahead of the election is MXN.  It is basically unchanged this morning, a perfect description of the narrative that the election will be extremely close.  However, a quick look at its price movement over the past week shows that it follows every bump in the polls.

Source: tradingeconomics.com

And that’s really it this morning.  We see the Trade Balance (exp -$84.1B) and ISM Services (53.8) but honestly, nobody is going to respond to that data.  Instead, all eyes will be on the early exit polls and the reporting of how the election is going.  No matter what, it seems hard to believe we will really have an idea before 10:00pm this evening, and then only if it is a blowout in either direction, seemingly a low probability.  So, today is a day to watch and wait if you don’t already have hedges in place because honestly, it’s probably too late to do anything now.

Good luck and go vote

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