Ok, it’s just getting comical now. Everyone is saying what I’ve been saying for months – no, years.
Obviously, the entire Heisenberg raison d’être revolves around markets being increasingly driven by macro and macro being increasingly beholden to politics.
Well, if ever there was an environment where that holds true, it’s this one.
But people aren’t acting like it.
In the US, stocks are pricing in exactly zero knock-on risk from a possible adverse result in any one of the three big elections in Europe (the Netherlands, France, and Germany). The VIX term structure looks nothing like the VSTOXX term structure.
And even in Europe, markets are sleepy. As one trader pointed out on Tuesday:
- French 10-year yields are only just above 1% – they were twice as high three years ago.
- In fact, it was not until November 2014 that they’d dropped as low as the current level.
- Some might object that this overlooks the spread-widening to German bonds. But that spread is half the level it was in both 2011 and 2012, when France was still considered part of the core.
Of course some of the complacency might well be attributable to the fact that the market still doesn’t believe the $400 billion per quarter central bank liquidity backstop will be taken away this year.
Here with some further color on this dynamic is the always insightful Richard Breslow.
Via Bloomberg’s Richard Breslow
This was supposed to be the year traders were going to be hamstrung by political risk. When the late 2016 trends faltered in the new year, this was a common explanation for why. That theme has been swept away. Investors insist on living only in the here and now. After all, the bullets aren’t flying where they care. How many times have you been asked how much of all this geopolitical risk is priced in? The simple answer is, not at all.
- For every well publicized lottery ticket being bought on German yields collapsing after the French election, there are other traders buying euro upside believing the National Front can’t possibly get through the second round. And lottery tickets aren’t hedges. They don’t protect the mass of stacked trades being built up. At best they may provide a modest pricing buffer as everyone heads for the same exit
- U.S. equities are so bid that on days when futures are down a point or two before the cash open, I’m asked what the problem is. But it’s not just the S&P 500 and Dow being fueled by tax cut and deregulation hopes. It’s everywhere
- Remember how we worried about emerging markets in a strong dollar, rising interest rate and growing protectionism environment? No need to worry. Or at least not to have played from the long side. Change the story line to reflation reflecting strong growth, and you have an MSCI emerging markets currency index on an absolute tear. Not to mention the emerging market equity index soaring.
- Far more importantly, the Bloomberg Barclays EM credit spread index continues to narrow at a breathtaking rate. “Give me yield, I’ve got payroll to make.” Now more than ever, it’s “Damn the torpedoes”
- If there’s one financial-crisis legacy that has in no way abated, it’s the insatiable desire to chase yield whatever the risk. After all, the models have learned to believe that the central banks won’t ever let financial conditions get out of control. I make the money, you manage the risk
- President Trump giving Taiwan back to the Chinese didn’t eliminate every other bilateral line in the sand between the two countries. Suddenly it’s great to be situated between Russia and NATO?
- Traders of other people’s money continue to resolutely compartmentalize what they perceive as economic issues from political ones. It’s a counterintuitive, yet predictable, strategy in what was supposed to be the year of political risk
