May 26. Bear market in volatility continues
–Though news reports about interest rate normalization have become much more prevalent recently, last week’s market action is anything but normal, like a black hole of vol and yield spread compression. There is now only one 1-yr calendar spread in euro$’s over 100 bps and that’s EDZ5/6 at only 102.5. (Down from 115 at the end of Apr and 107.5 from previous Friday). Red/green pack spread is just 98. As stocks move to new highs VIX has been crushed to new lows. Merrill MOVE index near new lows, FX vols also in the dirt.
(Helpful vol charts here: http://www.zerohedge.com/contributed/2014-05-23/trading-floor-insights-brad-thomas )
–As I googled ML MOVE index I happened upon Merrill’s Private Banking top ten themes for 2014 (written at the end of last year). The first one, ordinarily a slam dunk, was that stocks outperform bonds (duh). But not so far this year. Theme 5, “FI is challenged by greater interest rate volatility.” Nope. Theme 9: “Hedge funds and private equity beat commodities.” Yet hedge funds have negative performance for the year, gold doesn’t. CPI for beef and veal is up 10% in 2014. The Dept of Agriculture is warning of food sticker shock due to CA’s drought. The Chicago Fed’s cafeteria is raising its prices as “prices continue to rise between 3% – 33% We’ve got plenty of inflation, but not the critical piece: wage growth. (Mauldin) “Lower-wage industries constituted 22 percent of recession losses, but 44 percent of recovery growth.”
http://www.zerohedge.com/news/2014-05-25/and-worst-performing-strategy-2014
http://www.pbig.ml.com/publish/content/application/pdf/GWMOL/ARBPB3XY.pdf
–Current sentiment seems to reflect a massive pool of capital desperate to capture the remaining few bps still scurrying about, with the goal of “outperformance”. So naturally premium sales (everywhere) are the way forward to enhance yield. Mauldin’s latest missive refers to a “bubble in complacency.” There was a guest post on ZeroHedge which suggested the market wasn’t “paying attention” to this important vol implosion, but I can only comment that mkt participants are painfully aware of this forced environment. If the music’s playing, you’ve got to dance…
–Added to the concerns of capital pools seeking both safety and yield is the global rise of nationalism and related revolt against the status quo and inequalities. Elections in France and the UK present serious blows to the EU. It was nearly two years ago that Draghi used his “…whatever it takes” phrase to save the euro. We may be on the crest of a bigger challenge. Nationalistic moves in Ukraine, Russia, Vietnam, China, Japan may presage a reduction in global trade. Not too surprising to think that unfettered global capital seeks refuge in US markets. Or maybe it’s just that everything is smooth sailing from here…
–Circling back to the rate normalization theme, there has been a huge buyer in Short (red) Dec 9900/9875ps vs 9937c and in 9912/9887 put spreads. (ref 99.13 in EDZ5). Previously, heavy bets had been placed in Green June puts to play for the timing of the eventual Fed move, but with only 3 weeks to go, there has been a shift to this longer maturity option on a nearer contract. By far and away the most open interest was in Green June midcurve puts at 1.888 million. With huge put spread buying in the past two weeks, Short Dec is making a run at this amount, with 1.202 million puts on the books.
