“Tortured Traders” And Uncertainty: One Trader Weighs In On Spooked Markets

I’ve talked  exhaustively about how markets aren’t really good at what they’re supposed to be good at.

That is, markets are supposed to be discounting mechanisms, but in reality, that’s a misnomer. You can’t price in the sh*t that actually matters. How do you, for instance, “price in” a tail event? You can’t. That’s why it’s a tail event.

Markets always misprice risk. It’s just a matter of finding the markets that have mispriced it the most and staying well away.

For instance, I’ve noted that the VSTOXX term structure and European sovereign spreads (particularly evident in OAT-bund spreads) are at least trying to price some event risk around the French elections. Sure, € IG credit has fallen behind the curve in terms of spread widening commensurate with French corporate debt’s dominate position in the composition of € IG indices, but on the whole, Europe is at least making an effort.

That’s in stark contrast to US markets, where the S&P implied vol term structure admits of no kinks and where last month was the 3rd and 5th calmest January in history based on average VIX level and realized vol, respectively.

Some of the “complacency” in US markets may not actually be complacency. It may be more of a “deer in headlights” dynamic. That would mirror the Fed, which appears to be stuck in suspended animation as the enormity of having to incorporate the entire universe of possible outcomes weighs on the committee’s ability to make a decision. It’s policy paralysis and that paralysis is showing up in how markets are trading. 

For more on that, let’s go to FX trader turned Bloomberg contributor Richard Breslow.

Via Bloomberg

Familiarity hasn’t bred contempt, but it’s made a lot of traders get sloppy in their methodology. Equities quite aside, a host of the marquee assets are defying the storyline and remaining caught in narrow ranges. Yet we constantly see examples of high volume trading conducted at horrid price levels. And all that has led to is a wash, rinse, repeat pattern of buy at recent extremes expecting a break-out, get stopped out in summary fashion and wait around to do it all again.

  • The things that are trending, emerging markets and equities, everyone wants to hate. After all, how dare they do so with a world of uncertainty out there. They’re supposed to be the feel good assets. But if you look at bonds, currencies and, yes, even commodities we keep seeing these prices over and over. No matter how we spin the Fed or geo-political story in any given week
  • Let’s go back to Dec. 14 of last year. The day the Fed last raised rates. And released a set of aggressive dot plots that got everyone talking. Think of all that’s happened since to our perceptions of the economy, the new U.S. administration or European politics
  • Since then, the U.S. 2-year note has traded in a paltry 17bp range. Even after what one commentator called Yellen’s Valentine’s Day massacre for bonds [Heisenberg: ring a bell?] , we ended up nowhere. A few basis points from the average price for the entire period
  • Yet if you look at intra-day charts, it’s easy to see that the meaningful volumes kept taking place at highly disadvantageous levels. Giving no room to be wrong. No buying the dip here. It was sit around and buy the spikes
  • The UST 10-year has similarly tortured traders. The great 30-year trend isn’t ready to break, but it all refuses to go pear-shaped in a world possibly reflating. We’re almost at its average yield since the rate hike and at levels we’ve seen oodles of times
  • USD/JPY has broken out to the upside, broken down from crucial support and yesterday traded within 17 pips of its average price. EUR/USD is doing the same thing
  • I’ll let you look at the Bloomberg commodity index, where you’ll also see the mug’s game nature of any strategy that didn’t play the range
  • Yesterday, NY Fed President Dudley said it was very unusual to see stocks rising when there’s so much uncertainty. True, but they’re getting a lot of help on the regulatory and tax side. But there’s no evidence in other markets that everyone has a clear vision of the path ahead

 

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