Hiatus

As we know, this year has been all about the vol of vol: wild swings from worry exploding into fear, versus exuberance exploding into mania. The surprise has probably been how much more of the year has been weighted onto the exuberance side of the scales. But as discussed, it’s not actually (yet?) that irrational. Actual and implied volatilities are low enough to encourage the ongoing bid into risky assets. Central bank action into Lower Forever provides the support, and relative political stability with an absence of black swans provides the continuation. If anything, it’s our panic-about-a-potential-panic that suggests we won’t have that panic. The Ghosts of Lehman Past haunt us into precautionary saving, but it’s precisely that behaviour which keeps the Ghost from our door. Basically, we are already ready for something bad to happen – just check out how cash balances have been rising in the BAML Fund Manager survey: image

That’s why there is still a wall of money available, and that’s why we continue to see a melt-up in equities, even as some very unquantifiable political risks are just around the corner (Trump Presidency / Italian election / Brexit negotiations, to name but 3). The big question until the end of the year is whether we choose to ignore these worries, or they manifest themselves. The Citi Macro Risk Index has sunk to its lows for the year – and into the zone of the mid 2000s, where macro was dead:

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If we remain below that 0.6000 level then you know it’s perfectly rational to continue to pile into carry-type strategies. Looking again at our favourite bellwether, the South African Rand, it is actually well within historical norms in terms of the payoff for its yield versus implied vol (bottom right hand chart below, which shows 3month implied yield vs 3month implied FX vol):

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As BM readers know, we are now expected to be in a hiatus, as we hand over from monetary policy into fiscal policy, and the market adjusts from central bank watching to politician watching. So the only thing that could up-end the exuberant joy is if the volatility side of the equation shifts. There are indeed few macro risks on the horizon in the next few weeks, but we don’t necessarily need a data point to shake things up. Blondemoney will be keeping an eye on yield curves. They have now flattened back again, which is a positive-for-risk type move:

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But it is a very not-positive-for-the-BOJ, who’s recent decision was entirely predicated on getting the yield curve steep enough to protect the banks. This is where it gets interesting with regard to their decision this week. They decided, as we know, that their Spanx-like “Yield Curve Control” means the 10yr JGB should yield zero. But oh no, check this out, it’s only become more negative since they said that:

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Which means, if we are to take them at their word, that they should in fact be SELLING bonds to drive this yield back to their zero percent target. Oh yes a monetary tightening. With USD/JPY nestling on its 100 support. If you are looking for an accident waiting to happen, keep an eye on this one. If you’re more optimistic, enjoy the hiatus!

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