Jan 21, 2016. Davos frets
–Top headline on today’s WSJ: Markets’ Panic Incongruent with Economic Reality. A little cheerleading to start the day. However, the guys in Davos are circumspect. Telegraph’s AEP highlights a few views (link below). From the IMF’s Zhu Min, “The key issue is that liquidity could drop dramatically, and that scares everyone.” From Kenneth Rogoff: “What is driving this is that the central banks are not coming to the rescue,” he said… Rates are already zero or below in Europe and Japan, and quantitative easing is largely exhausted, leaving it unclear what they could do next if the situation deteriorates.
–The ECB is on tap this morning, the Fed next week. High profile warnings yesterday from Dalio, Gundlach, William White, etc provided a sharp sell off that broke August lows and provided opportunity for short covering as early panicked selling was quickly exhausted. But it doesn’t mean the move is over…in the short term it comes down to central banks’ response. China continues to ham-handedly provide support, but if Rogoff is right, then there’s more equity carnage to come. I saw several views noting that VIX hadn’t yet seen a surge that indicates peak fear. However, the comparison is with August, when China’s devaluation was completely unexpected. This time things are more controlled. If we ignore the VIX spike in August, then yesterday’s high of 32 is the highest level in 4 years. (I don’t think a break of the Saudi dollar peg will elicit the same type of surge as China, but that’s likely coming).
–Where the vol situation might also become significant is in interest rate markets. A friend from the ED option pit notes that the pit (mkt making community) is short in size. It always works. Except that even now vols are not tremendously expensive, and if central banks flub it, premium will inflate. Hard.
–In terms of market action, near eurodollar calendar spreads again made new lows. The first two 3-mo spreads, Mar’16/Jun’16 and Jun’16/Sept’16, both settled at just 6.5 bps. The one year spread March’16/March’17 settled at 29.5, just barely above a quarter percent –one hike in a year. C’mon Fed. Embrace what the market is telling you! Treasury yields fell, with tens down 5.6 bps to 198.4, essentially at the lowest closing yield level seen last October. In options, there was liquidation of over 100k 0EH 9887/9900/9912 c trees at 0.5 and 0.0, having been entered at 3 to 3.25 on the buy side. Market went up a little too fast, too much.
http://www.telegraph.co.uk/finance/economics/12110415/Fears-of-global-liquidity-crunch-haunt-Davos-elites.html
