Ripening

The hiatus continues – by which we mean that warning signs are building, even as market volumes are light. Yet again, we are already panicking ahead of the panic. The latest BAML Fund Manager survey shows cash levels climbing again – now reaching the highest allocation to cash since 9/11. So what’s left to liquidate? Well… let’s all hail the new tail risk on the horizon… shooting up the charts, out of nowhere last month, zooming into the top 3 concerns for the world’s fund managers, it’s: “Crash in Bond Market / Rising Credit Spreads”. Perhaps Donald Trump should take note that the bond market can even bully him, with “Republican Winning the White House” pushed down into third place.

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So, with this risk on the horizon, and cash levels so high, does this mean that investors have already enacted this panic? Markets tend to rehearse various scenarios as they become more probable – but then fall back quickly once the reality does not keep up with the expectation. In such a way, the Euro didn’t disintegrate, the Greeks didn’t exit, the US debt ceiling didn’t implode and Brexit didn’t (yet?) kill the UK economy… and so on and so on. With volatilities so depressed via the combination of central bank intervention and a virtuous circle of ‘low returns means more risk taking means lower prices for risk means lower returns means more risk taking’….. is it any wonder that the snapback to reality is happening ever quicker these days?

So for this to break, we need a shift in the expected future path of the world. Sometimes that comes because of an event. In the past we have had examples such as QE is unexpectedly announced / Russia invades Ukraine / OPEC fail to reach an agreement, etc. New information is presented to us.

But sometimes it can be a shift in the perception of the information that we already have. For so long we have been suckling on the cheap money teat of our benevolent central bank guardians that we don’t want to think it could ever end. In fact, we can’t think it. It’s a risk that fell off the radar. But take a look again at that “tail risk” chart. A new entry at no. 5: it’s “Tapering by ECB/BOJ”. Ironically, this is now as big a risk this month as “Helicopter Money” was last month! That kind of swing in sentiment is what happens when a change in perception begins. It’s small at first. It niggles at the back of your mind. A few people might mention it to you. You dismiss it. Everyone is buying risky assets and you need to get involved! Ok so what do you do as the niggle gets bigger… you put aside some cash to protect yourself. Now that’s like a pill for the niggling headache – it makes you feel better in the short-term but long-term can you really shift the concept that the world might be changing? That actually, it was always insane for corporates to begin to issue at negative interest rates? That the free money wasn’t doing anything aside from harming bank profitability? That the politicians now need to take over?

That this is, in fact, The End of Monetary Policy?

We may not want to believe it, but at least now we are entertaining it. What would prompt a further shift in perception? Well, step forward Mr. Draghi, in tomorrow’s un-eagerly un-anticipated ECB meeting. EUR/USD breakeven is 75 pips. That pretty much means hardly anything is expected.

Time for the Taper Rabbit to emerge from the hat?

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