However, if the bonds are not rallying purely because of less inflationary hawkishness by the Fed then that the market, desperate to link any story to a large move, has mistakenly latched on to the wrong story to explain the move.
The inundation of stories and ‘Outrage Fatigue’, means the attribution of a wrong theme to an asset’s move happens much more frequently than before. Although, often asset classes move because of over positioning, market participants always need to link some fundamental justification to the moves. If they latch one story and the positioning does not get extinguished, it is likely another story will be tested and then squeeze the positioning more, and another, until the positioning flattens.
WITH ‘OUTRAGE FATIGUE’ COMES LOWER VOLATILITY. UNTIL IT DOESN’T. As some will know, I was one of the first people to be a trader on the options floor in London. There was no mention of volatility until the mid- 1980’s and, even then, very few people had any idea of what it meant and how you could orchestrate your total risk exposure by using it. The few who did, made a lot of money. The VIX was created and launched in the early 1990s. VIX futures and options came into play in the mid- 2000s and now, less than 15 years later, it is the leading risk matric.
VIX has been falling for nearly as long. Anyone who was short volatility for the last 10 years has had a rolling field day. The stability of markets that created this ‘nirvana’ was in no short measure due to the Fed put discussed earlier. The free put that the markets were given obviously lowered the price of buying a real put. The Fed were always allowed to write this free put because, during the period, inflation was so benign, mainly due to globalisation.
THE INUNDATION OF STORIES AND ‘OUTRAGE FATIGUE’, MEANS THE ATTRIBUTION OF A WRONG THEME TO AN ASSET’S MOVE HAPPENS MUCH MORE FREQUENTLY THAN BEFORE.
13 | ADMISI - The Ghost In The Machine | May/June 2018
We are now at a juncture where any further flourishing of economic conditions looks likely to produce at least a tincture of inflation. Now is the time for central banks to rebuild their defensive walls by raising rates to give them ammunition in future, to cut them again. If they don’t, inflation scare stories will start to dominate, right or wrong. If they do raise rates, weak economy scare stories will surface. That appears a binary event for bonds but a lose/lose for equities. Whichever the route, the outcome is likely to be more volatility. The longest bull market that most have ever seen has increased leverage outrageously as hedge funds (and all investors) try to create double digit returns in a severely single digit rate environment. That leverage has done investors proud, so far, but it simply cannot continue if volatility picks up.
My premise is, as you will have read, that news flow has become bountiful and, through that, artificially sensationalised and consequently less market moving. However, the market driving news going forward, inflation and the economy, will become less nuanced and more statistically founded. The Fed put is disappearing, which raises volatility. High leverage cannot survive with increased volatility and, if leverage gets unwound, it causes losses and more volatility and thus a vicious circle starts.
Andy Ash E:
andy.ash@
admisi.com
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