We Interrupt Normal Programming for....Vol!

Alright, so at some point in the next few weeks, we’re going to be able to start analyzing markets again without simply writing off the most recent price action to bubble-mania, bitcoin flows, stock-and-trade momentum, or any other fanciful unintelligible metric of your choice.

Let's go to the facts:

• The Treasury curve is bull steepening, indicating there isn’t much of a change in long-term sentiment, but a modest re-pricing of short-medium term expectations for the hiking cycle.
• More to the point, there hasn’t been a big bounce back, FTQ flow, or simply a material reversal in UST term yields. Look, there’s another 30bps to go in UST 10yr before we get to where we started the year. And I repeat, the long bond at 3% and a 30yr fixed mortgage at 4.25% won't bring the economy to a screeching halt.

• Sticking with rates...credit markets aren’t showing any stress either--HY is down less than 1% for the day, and IG credit indices are something like 4bps wider on the day. Color me unimpressed with this state of panic--not two years ago that type of vol was just another day at the office.
• And looking at another of our favourite markets,  the USD is far from reversing...in fact we’ve just now given up a week’s worth of gains in DXY.  Not much to speak of here, until we start looking at the 1.20 level in EUR, or taking out 112 in JPY.

• Similarly, if I were to do something reckless like use usd/mxn as a proxy for global EM currency risk appetite, it is clear there is a long way to go to reverse out recent gains:

• Meanwhile, more prosaic markets--yet those linked to global demand and the manufacturing cycle, have been stable, nearly boring. Take a look at the copper chart, which has lulled traders to sleep, despite “accelerating global growth” being the talk of the town:

At this point, it appears we’ve burned off the 5-6% outperformance in the US equity market...a market that nearly the whole world said was some combination of illusionary, a “melt-up”, driven by January retail flows, or simply nuts...all with relatively little collateral damage.

So what’s going on? Can this degree of vol really be isolated to such a deep, liquid market? Let’s take a look at the chart that ties it all together….frequent commenters know what’s coming next:

That’s the VIX, going out today above the magic 30 level, higher than only one other data point in the past five years, which was right after the Chinese destructo-deval of August 2016. Put another way, this measure would indicate we're at levels to suggest widespread panic, blood in the streets, and margin departments gang-pressing Park Avenue passers-by into temporary service.

Now stop and think about just how complacent this market has become, just how much money has flowed into short vol, or gasp, levered short vol, how pension funds now think short vol is a high-yielding asset class, and how there is just a ton of traders that have gotten fat and happy collecting short gamma nickels.

The gamma check has come due...never send for whom the bell tolls; it tolls for thee.

With the S&P looking set to close at late December support levels, the overarching message is there isn’t a genuine change in macro sentiment, but rather a reversal in a market that had simply gone too far, too fast dependent on an avalanche of money, momentum and hope.

I don’t want to use the term “healthy correction”, especially in a market that was high on financial amphetamines rather than "healthy" to begin with.  Yet there is little evidence to suggest this selloff is global in nature but is instead blowing off the exuberance of the past couple of months. Will it continue? I’m skeptical the party is over--I see no reason to change my optimistic view of foreign assets....but the sordid short volatility tale may just be getting going.

Shawn
TeamMacroMan2@gmail.com
@EMInflationista