Former FX trader Richard Breslow is back off the weekend, and seems refreshed – where “refreshed” means not chomping at the bit to berate you.
This morning’s missive is more reflective and the theme is familiar, although it reads a bit like Breslow walking back his contention that markets need to take central banks’ collective effort to lean ever-so-slightly hawkish seriously.
But while in today’s centrally planned markets, “a discussion of when to buy often begins even before the sell- off,” it’s important to remember that the BTFD mentality ironically rests on the notion that central banks are still buying. “I’ll buy the dip, if Draghi keeps buying bonds,” etc.
The real test will come next year when the market has to absorb $1 trillion in securities as the ECB steps away and the Fed begins to shrink its balance sheet.
But perhaps the most notable point from Breslow’s Monday note is this:
Ultimately, there can’t be normalization without exposing markets to the same concerns as the citizenry at large. The divide in levels of being appalled by goings-on is dangerous and as much a fuel of populism as other, more obvious causes.
In short: at some point markets will need to be allowed to price political risk just as voters are forced to shoulder the psychological burden that comes with political upheaval.
Right now, markets have been spared that responsibility and nowhere is that more apparent than in the steady grind tighter of € credit despite the myriad political land mines we’ve traversed since Brexit:
And that is of course a cause and an effect of low equity vol.
Find Breslow’s full note below…
Global equities are higher, fueled by Emmanuel Macron’s big win in France’s National Assembly election. The euro is virtually flat versus most major currencies as the election results were well anticipated by the markets. Can both explanations really be true? Yes, they sure can.
- What we are seeing in the markets today is where asset prices want to go in the absence of new news. Simultaneously, the path of least resistance and infliction of most pain. Call it what you want, but the screens scream happy. It’s summertime, and investors are impelled to keep taking advantage of everything that’s worked so well from policies targeting happy financial conditions
- Sure, the Fed is talking tough. And a lot of other central banks are trying it on for size. “See, that didn’t hurt too bad, did it?” But traders are betting it will all be manana. That no one setting policy will let the applecart be upset and they will so over-communicate that there is in fact no risk. Risk isn’t being underpriced at all. It accurately reflects a sober, and sobering, reflection of ongoing central bank reaction functions
- Which means while we have periodic, real and contrived upsets, they are ultimately dismissed and faded. A discussion of when to buy often begins even before the sell- off. This means that when things do get out of hand, traders will react to it in a clumsy and leaden fashion. And the inevitable cause is going to be something central bank- derived, because it’s the only reality check on carry that they too will be slow to react to
- It’s unlikely to have anything to do with the rather healthy and measured tightening we are going to see. But everyone pushing peripheral spreads toward “risk, what risk?” levels should consider what it might mean when quantitative easing is gradually removed. Unless you actually believe that the ECB will finally abandon the Capital Key and the Macron election will inspire Germany to start writing insurance on Europe-wide debt and financial institutions
- Ultimately, there can’t be normalization without exposing markets to the same concerns as the citizenry at large. The divide in levels of being appalled by goings-on is dangerous and as much a fuel of populism as other, more obvious causes. It won’t be cured by a couple of disaster-avoiding moments in European elections
- Lack of market-priced implied volatility is a sign of distress, not calm. It means that, quite wittingly, we are still in crisis mode