The title of this post has already been taken

The obvious title of this post, to continue a theme, has already been taken. But the message is still valid. So far this week, signs of distress and, yes, panic, remain evident in financial markets despite the unchanged close in US equities yesterday.

The newsflow has not been particularly encouraging:
* Capital One closes its mortgage business
* Thornburg Mortgage has puked some of its portfolio and taken a charge
* Solent Capital, a UK hedge fund/SIV manager, considers changing its name to 'Insolvent Capital'
* Rumours abound of a UK insurer going bust
* Queues are beginning to form at CB discount windows

Remarkably, the yield on 1 month US Treasury bills traded below 1.3% yesterday. That is pretty amazing, given that Fed funds remain at 5.25% and that 1 month LIBOR fixed at 5.50% yesterday. Whoever was buying bills at those levels was presumably not doing so as part of any kind of investment strategy. If ever you needed proof that focus has shifted to return of capital rather than return on capital, that is it.

Everyone's new favourite indicator, of course, is the TED spread, which was last relevant to global markets at roughly the time that Liar's Poker was published. This indicator measures the difference between the yield on three month Treasury bills and 3 month LIBOR, the interbank borrowing rate. Like swap spreads, it is used to measure the level of distress/panic/praying in the financial system. The current reading is not particularly pretty.
The current reading is the highest since 1987- or is it? While the three month TED spread was wider than 2.5% in 1987 (and substantially wider than that in the 70's and early 80's), those reading came with interest rates at or close to double digits. Expressed as a ratio (i.e., the current 3 month LIBOR rate is 1.71 times the 3m T-bill yield), the spread is the widest that Macro Man can find in his data set. So quite clearly, there is indeed panic on the streets of London....and Frankfurt...and New York...and Tokyo.

Another sign of distress has been the complete implosion of the Russian basket trade, where rouble weakness has more than wiped out the last two revaluations by the CBR. While not fail-safe, this trade was widely thought to have the best risk/reward characteristics in EM-land. Indeed, until a couple of weeks ago Macro Man was involved in his real job. The dislocation this morning suggests, like the TED spread, that positions are being liquidated out of necessity rather than desire.

For the brave, this environment can ultimately set up some real bargains. However, it is important to wait until the period of maximum pain and panic. Something tells Macro Man that we're not there yet. Thus, while the CBR is, to their credit, offering the basket just above current levels, this is no gurantee that it cannot widen further. After all, the ecu basket trade, for those that remember, widened much more substantially in September/October 1998, only a couple of months before it was guaranteed to go out at par. The message here is that nothing is guaranteed and that everything can move more than you'd think.

If Macro Man has maintained one purely financial market theme this year, it is that volatility is likely to be higher in the future than it has been in the past. One rationale for that view is that monetary conditions, while not restrictive, are no longer ludicrously easy. The chart below illustrates a proxy for global monetary conditions (where 0 is neutral, below there is easy, above there is restrictive) overlaid with a moving average of VIX. There is a reasonable correlation over long periods of time, and the policy indicator has been hinting at higher volatility for some time- one reason for Macro Man's conviction that vol has been set to rise, and his preference for hedging risk positions when the opportunity arises.

Tomorrow, Macro Man will look at global liquidity conditions and why he remains, in the medium term, constructive on risky assets.