One Trader’s Message To Markets: No, This Is Not A “Bad Dream”

Normally, my sentiments with regard to markets align pretty closely with those of former FX trader and Bloomberg contributor Richard Breslow.

His daily missives usually hit my inbox between 2 and 3 a.m. EST. My mornings typically start with a combination of Breslow’s wit, the (shrill) sound of the cappuccino machine reluctantly warming itself up, and the ring-shaped ghosts of a cigar floating away out the cracked living room window (h/t Erik Larson).

This morning, I don’t agree with Breslow. Or at least not totally. His suggestion is that markets need to stop pricing for rationality. That is, traders shouldn’t be surprised when Donald Trump say, insults a civil rights hero on Twitter. Or tacitly suggests the US should burn NATO to the ground. Similarly, traders shouldn’t act as though they thought Theresa May would come to her senses on Brexit. Finally, traders shouldn’t assume that geopolitical risk can be written off because they’ll always be a central bank liquidity backstop.

On the last point above, I certainly agree. I’ve been saying for years (literally) that geopolitical risk is never properly priced and that makes the conditions ripe for multi-sigma tail events. On the other points, I’m not sure I concur. That is, I’m not sure it’s unreasonable for markets to expect world leaders to exercise some degree of restraint and/or show some reverence for societal norms.

You decide…

Via Bloomberg’s Richard Breslow

Investors won’t be able to trade markets if they can’t settle on a base-case scenario. And they have to accept that some unknowns are less unknown than others. Every tweet that restates what Donald Trump has been saying consistently for many months shouldn’t come as a surprise to traders and send global asset prices into a tizzy. The same goes for today’s speech by U.K. Prime Minister Theresa May.

• If people are on edge waiting for the next installment on protectionism or a hard Brexit, it should be because their positions would be affected on the chance that the messages are reversed, not reiterated
• There seems to be this enduring tendency for market participants to believe that these politicians will “come to their senses” and this will all have been campaign or negotiating tactics. A bad dream. It’s why his election night victory speech had such a profound effect. But whether you like what’s going on or not, you need to position for the most likely scenarios and what you think it means for markets. On the latter, opinions may differ and that’s all right. But don’t feign being surprised that some pretty remarkable things are being said and proposed — regularly
• For years, post-financial crisis policy was conducted on the self-serving belief that it works best by propping up asset (especially equity) prices, which will then cause some of the goodies to trickle down. Known in the non-official journals as “cure through greater inequality”
• Traders, and I guess the clever people who program computers, can’t get this out of their heads. Of course we’ll eventually get market-friendly prescriptions. So we’ll always price for that outcome. It’s a big part of why geopolitical events have notoriously had such little effect on markets. There was always more liquidity in the bag
• It really isn’t profound to point out that if global politics turn decidedly ugly, it could act as a drag on world growth. Unless you assume you’re owed a policy response just as soon as it happens. Now that’s an assumption that should be weighed carefully