What Event Risk?

Exhibit A: ECB changes from the last meeting to this meeting

: no discussion of QE ending
Now: anticipates it will end in December 2018

Previously: rates unch ‘as long as necessary’
Now: a hike in >12 months time. If you had read the above changes a couple of months ago it would have looked as hawkish as you like. Instead, EUR/USD had its biggest daily down-move in two years.

But you, faithful BlondeMoney reader, know why, right? You read Thursday’s note and you know that it is that spooky short gamma stuff again. In layman’s terms it just means that options market-makers leave stop-losses in the market, so that when something goes, it really goes. We’ve seen a lot more of this since the February volatility blow up, as hedging behaviour has had to take the extra volatility into account.

We also know that it means we get violent moves, more protracted than a flash crash, but which eventually reverse. So let’s see if EUR/USD can bottom out around 1.1500.

It may be challenged by the fact the US Dollar is back on another tear as the EM sell-off continues. We know about that one too, don’t we? It’s genuine flow-driven risk-adjustment. Just as the options guys altered their hedging behaviour, so the longer term investors got the same signal that higher volatility means trimming of positions. That means “hey just take some EM off the table and put it into, I don’t know, something with momentum… what’s been going up a lot, came off and going back up again…? Facebook you say?”

Yeah that’s the second biggest weekly inflows into the tech sector ever folks. Just as $10bn came out of EM in the last six weeks, according to BAML. The shares outstanding in the largest ETF on Brazilian stocks, the EWZ, have maintained their highs even as the ETF value plummeted – meaning the shares are in demand to lend out as shorts:

And so the EM rout continues. It’s like the event risk is the pause before the real story comes back. Which is that the cheap money party is over and liquidity is being sucked out of every asset class, one by one. You knew this story, you read these pieces, and hey if you don’t, you can read them on the Market Watch column which featured your favourite Blonde yesterday:

It’s no wonder the “50 cent” VIX trader is back, buying VIX call options with a strike price of 28 that expire in August. It’s likely to be the tail hedge for a portfolio, but it suggests they’re aware that our two main driving factors of liquidity and leverage are more likely to be exposed over the summer.

Event risk merely provides the opportunity for us to see the skew in the market that already exists. Facebook, Italian bonds, Russian stocks, Argentina, Turkey, Mexico, South African Rand – they were all just too expensive. At least they are when political risk is so high and the free money methadone being withdrawn.

We still wait for the shoe to drop on our two other favourite overvalued assets: Credit and GBP. The former has had a small wobble with those SHYG outflows but much more is to come now the Fed are on course for another 4-6 hikes in 18 months. The latter should get a shake from another Parliamentary vote next week. It turns out the amendment the Remainers agreed to is one that can’t be amended. A vote now to let Parliament have a meaningful vote later would only allow Parliament to vote Yay or Nay rather than amend what they’re voting on.
If that makes your head spin, you only need to ask yourself this: where should UK assets be priced if parliament spends it time amending amendments rather than agreeing on a deal? 
Right now the answer is that their pricing is confidently unchanged because the parliamentary stasis means the UK will just end up accepting a status quo transition. If that supposition should change even slightly, then long-term flows and options trades could rapidly alter the picture.

A loyal reader reminded BlondeMoney of this chart from the BOE, depicting the order book in GBP/USD during the flash crash of October 2016:

The bits without colour are where the bids just disappeared. Instead of volumes of £50m every second it dropped to less than £2m.

Event risk is just the excuse to shine a searchlight on where those gaps of white lurk beneath the surface. Get out the torch folks and get hunting…

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