The Quincunx Page Turner

First, let me say that this post is primarily a page turner. Turning the page on the blog to free up white space for the comment section to use as the last one is a bit full. It is purely a lift of a post I wrote elsewhere and should be considered as Polyfilla in the decorative works of the new TMM2.


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It's been a while since I last posted as I have been waiting for the realisation that Trump was not going to be a shoehorn to economic prosperity to dawn, as his extremes either shock the rest of the world into moving away from buying US assets or his changes collapse in a cloud of impracticality. Neither of which has happened.

My simplistic de-Trumping plan has turned from a binary game of all on / all off into a multi-dimensional game of chess. Hard Trump and Soft Trump, to borrow a Brexit phrase, are forms of Trumpism that are quantum-like and more probability waves than certainties. The strength of policy swings on a Tweet or judicial feedback. With foreign policy we have seen back peddling from 'hard' as the one China policy appears to have been acknowledged, Japan declared ‘best friend’ and Canada told that Trump is only planning ‘tweaks’ to NAFTA.

Yet the rhetoric against the likes of Basel III remains as strongly worded as ever and the deregulation of US banks could cause some of the greatest strains between the US and EU. Since the 2008 crisis regulations have been seen as much a moral crusade as one of practicality. Dodd-Frank and Volker, though nice ideas, were never fit for purpose and the laws of unforeseen consequences have produced all sorts of schisms, whether it is liquidity holes in corporate bond markets or just ridiculous generalised reporting conditions on markets that were not exchange based. So getting rid of these, or at least watering them down, would be a sensible compromise between practicality and moral protection. At least that’s the line I am willing to excuse the panel of top bankers currently advising Trump with.

Basel III is a bigger issue. If McHenry’s letter to Yellen is properly representative of new policy then it hits the EU head on. The EU has been proudly touting its new banking regulations which should identify weak banks (yes, done in style) and be part of the path towards a unified European financial system, whilst also allow the politicians to wave a huge moral flag in triumph. But what happens if the US banks are suddenly told they don't have to play by the same rules? They instantly have a competitive advantage unless the EU backtracks and loosens Basel III in response - Highly unlikely for them to do such a massive U-Turn just because Trump has pushed them into a corner - or they immediately remove the US’s European banking licenses if they don't comply.

This is al the more interesting coming in the wake of Brexit where apparently the US banks are threatening to up-sticks for continental Europe, well let’s be honest, it’s a threat as none of them really want to go. France may well be offering sanctuary to US scientists and the world's bankers, but if it were really that great they would have gone there already.

There is a small version of the State of Liberty on the banks of the Seine in Paris and I was wondering if they should attach a plaque to it similar to the famous one in one in New York -

Give me your scientists, your bankers, your huddled masses yearning to breathe free, the wretched liberals of your teeming shore. Send these, the visa-less, Trump-tossed to me, I lift my high tax rates besides the red tape.

But if the US banks aren’t going to be playing to Basel rules there may not be that tide of bankers. Indeed, the UK would be looking pretty as an intermediary between the two. It would also support another idea I was nursing, the introduction of an offshore Euro market in line with the original Eurodollar market. If London launched such a beast the EU would not be able to control it yet it would provide a method for EU unregulated institutions to fund and lend Euros just as the Eurodollar market did for Russian held dollars when it was established. The great thing about the City is that it has thrived on bypassing regulations, or rather, creating the most efficient systems to mitigate their impacts. It's what it thrives upon.

But back to the markets, I am lost. I see risk piling up everywhere except in the markets, which are driving on upwards. I don’t need to list the European stresses but I think this sums up the EU's position pretty well.

There are so many possible outcomes to current uncertainties I am looking at the markets as a quincunx-  not a Harry Potter creature but another name for the 'bean machine' devised by Sir Francis Galton.

The box itself could even be used as a metaphor for Trump's policies. An Executive Order, or even just a tweet, is dropped in the top and it rattles down through so may deflecting processes that, though you think you have an idea where it is heading, the policy's final resting place may be some way off where it started.

Add in the rest of global politics and you end up with so many variables, or pins in the box, that the sum of paths may well mean that there are not any fat tails, but the standard deviation of the resulting distribution is a lot wider than volatility pricing is currently suggesting.

I have been discussing buying volatility now rather than direction as I was, or so far have been, wrong on direction but I am being amply reminded that the scenario we have could be looking like the great vol compression of 2006. With Mr. Cohn (bless his poor cotton socks having to take that meager compensation for having to give up his job at GS) at the helm, the perception is we are going to have a smooth path to financial wonderfulness with the lifting of bank restrictions and the extension of credit underwriting all risk. In a way it's a passing of stimulus back from public QE to the private sector banks, a pay off for, or by-product of, lifting the bank restrictions. Some would no doubt ask what happened two years later, but we won't go into that now. But, back to volatility,  buying vol doesn't necessarily need a turn lower in markets to perform, though falls in markets do drive up implied volatility. You can buy implied volatility and be measured against realised by managing the hedges rather than, as with the VIX, buying implied volatility and being measured against implied volatility. There is a big difference meaning you can make money being long vol on rallies, despite perceptions.

Especially when people gets squeezed out of a large short call positions.


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Right there you go commenters, new space to play with.