A few thoughts from Monday night NY time

Well, that was interesting.   Macro Man wishes to extend apologies to all readers for not informing them of his presence at a beach yesterday; the short trip to Rhode Island was a spur-of-the-moment thing, and your author didn't think that the "world goes to hell while he's on holiday" rule applied.  Mea culpa.

That having been said, those souls portraying yesterday as some sort of "Black Monday" were well wide of the mark.  Macro Man can only assume that they were literally playing with black crayons in 2000, and figuratively in 2008-09.

To be sure, the market liquidity environment was execrable, from the Chinese meltdown to the Nikkei meltdown to the DAX meltdown to the Spooz meltdown to the ETF meltdown to the USD/JPY meltdown to the subsequent meltups....and back down again.

Yesterday's hastily scribbled assertion that the time might be nigh to don the kevlar gloves proved wide of the mark; that having been said, the 30 level in the VIX did serve its purpose to a tee.  Spot VIX obviously gapped through the level (when it could be bothered to print at all!), but notice how the 30 level held almost to the tick on the equity uptrade before Spooz rolled over again and VIX rebounded.

If anything, this strengthens Macro Man's conviction of the utility of the 30 level as a tell.  While it is obviously nice to use massively oversold conditions to cover profitable shorts, Macro Man would be leery of running even the most tactical of longs until the VIX breaks that 30 level and heads lower.  Otherwise, that's not a knife you're catching with those kevlar gloves, it's a neutron bomb.

Still, it's been a while since Macro Man's been able to suggest a trade on Friday (short Nikkei) and have it some go nearly some 15% in the money on an intraday basis on Monday.   For choice, he would cover half of it here (17910 at the time of writing) and run a stop at the entry level on the balance- while being prepared to roll that down if and as the index makes new lows.

The reaction to yesterday was quite telling.  The closer you are to a P/L, the more interested you were to keeping your head down and figuring out what would happen next.   The closer you are to political office (current or desired), the more interested you were in casting blame for the unspeakable fact that markets went down.  Such is the realpolitik of markets in the brave new world of the modern regulatory environment.

What does make the current environment different from 2000 or 2008, of course, is the prevalence of algos in the market and the lack of presence of banks as risk-warehousing intermediaries.  Macro Man saw an interesting stat suggesting that while there were a record number of trades in S&P minis yesterday, there was not a record volume because the average ticket size was a mere 2.57 lots.  That's fairly astonishing, given that the minimum size is obviously..err....1.  Whether that meager size was down to the algos doing the trading in intentionally small sizes, an abject lack of liquidity, or both is of course an interesting subject for debate.

Macro Man looks forward to the report in 5 years' time damning some poor bugger living over his Mum's garage for causing today's meltdown.

In seriousness, however, the air pockets observed in so many of Monday's markets do not speak well of the micro-structure.  While China is of course a source of duress, imagine how bad it would/could be if the locus of distress was in the domestic real economy rather than speculative foreign financial markets.  It's high-hanging fruit, but regulators would do well do address issues related to "liquidity providers" and their movable feast of participation, even if they can't raise the sort of cash generated by LIBOR and FX fixings.

(As an aside, how do the regulators square the fines levied for those scandals with the paltry one levied on Citizens Bank, which was found guilty of literally stealing customer money?)

In the meanwhile, the structural failings of the market merely add to the volatility unleashed by the tightly coiled spring that has snapped back.   As Macro Man wrote on Twitter yesterday, Monday's price action was extraordinary- almost as extraordinary as the SPX remaining confined in a 5% range for 6 months.  You only need to observe one episode like this to learn that the longer that volatility is suppressed, the more violent the rupture when the low-vol environment breaks.

As for the Fed, obviously the deeper and longer any market correction, the less likely it is that they move this year.   That having been said, Macro Man does not agree that the chances have already telescoped to something approaching zero.  That the dollar took a bit of a beating yesterday- at least against the euro and yen- should give at least a little pause to the USD caveat expressed in the minutes, though of course on a TWI basis the dollar's weakening was less notable.

More to the point, while Macro Man has given the Fed plenty of stick over the years, even he doesn't think them so obtuse as to not recognize that this sort of reaction was at least somewhat possible in the run-up to any tightening.  As a result, he think that they'll play it by ear and not rush to judgment either way, a sentiment more or elss echoed by Dennis Lockhart's speech yesterday.

Your author can recall thinking in the immediate aftermath of Hurricane Katrina a decade ago that there was no way that the Fed wouldn't pause its tightening cycle to assess the (much more real) damage; two weeks later, and it was obvious that they were going to keep on truckin'.

Now obviously, that was Greenspan, not Bernanke (let alone Yellen!), and there's a massive psychological difference between continuing and starting a monetary cycle.  That being said, the point of the recollection was to illustrate how swiftly sentiment can change in a matter of a few days.  Intellectually, something close to a critical mass of the FOMC seems to have decided that they'd like to ditch ZIRP; as such, the news will have to remain bad for them to abandon that intent.

Maybe it will happen, maybe it won't, but with markets pricing only a 50% chance of any tightening by year end (versus 50% for September less than a week ago), the risk-reward is starting to look pretty good.  Macro Man sold a small initial clip of January Fed funds futures yesterday, and is hoping for a further rally so he can add to the position at even nicer odds.   It will take a hell of a lot in terms of news and price to push that totally to zero, so it should be an easy position to hold even if stocks take another downleg.

Finally, China.   A few minutes ago, Macro Man saw that USD/CNY fixed lower on the day, which surely illustrates the authorities' emphasis on FX stability as the rest of their world apparently crashes down around their ears.   There are some truly fantastic numbers being thrown about regarding intervention amounts, with the linked article suggesting $200 billion in the two weeks since the deval.

Simply put, PBOC could not extract that amount of RMB from the system without sterilizing (RRR cut/buying shedloads of T-bills) or causing a major money market rupture.  To date, neither has occurred, so Occam's razor suggests that the intervention size has been much smaller.  That having been said, the whole debate illustrates the opacity of the whole Chinese FX and monetary regime.   One thought that presents itself is that the next release of Chinese FX reserves will be very closely watched for clues as to how much firepower has been spent.

One cute trade would be to do a calendar spread, selling FX vol expiring before the release and buying some expiring soon after.  Bid/ask might be prohibitive, particularly in any sort of proper size; nevertheless, trying to figure out a way to game the idiosyncratic opportunity provided by a generally obscure piece of data is one way for the humans to kick the Matrix where it hurts.