June 30. The BIS weighs in on financial stability
–BIS is warning about a disconnect between euphoric financial markets (an echo of irrational exuberance?) and underlying economic trends, Bullard also warned last week that the market doesn’t get it, and neither does the Fed itself, but he’s quite sure that near term rate hikes are are the correct course of action. On the other hand, BoE’s Cunliffe warned against raising rates too quickly against the backdrop of a still fragile economy.
–Low volatility levels run through every asset class. Central banks have created the financial conditions that cause reach for yield, which in turn encourages premium sales as a way to enhance yield. Bill Gross alluded to premium selling strategies at his Morningstar speech.
–The problem is that at ever lower vol levels, gamma can quickly wipe those strategies out. And by “strategies” I mean “capital”. You make a bit of incremental yield slowly over time and then “Poof. It’s gone.” As a result of one violent move.
–Bernanke constantly assured the markets that when the time came to remove the kool-aid, the Fed would know it and would have the tools to shape a graceful exit. After an initial stumble, the tapering process has been pretty smooth. But now it seems that the stakes are being raised by the BIS, making Yellen’s upcoming performances at Humphery Hawkins later this month and Jackson Hole in late August loom large.
–ZeroHedge had a post citing Barclays Joe Abate that treasury delivery fails have been on the rise. The article notes that otr fives have been special (making it expensive to carry shorts) due to lack of collateral. Don Soldatis of our desk makes a related observation, that the put/call ratio in Five is quite high at 3.08 to 1. As always, it’s a bet on timing. The drip of negative carry versus the catalyst that creates the dislocations on which years are made and lost.
