The Calm Before The (Maybe) Storm

Just when it looked like things might be starting to crack under the weight of intensifying geopolitical tensions and the increasingly moronic trials and tribulations of Donald Trump, whose reality TV show self is trying its hardest to assassinate his Presidential persona, risk assets are back on the front foot Tuesday.

Although we still haven’t retraced the entirety of the “fire and fury” move in the VIX, Bloomberg’s Andrew Cinko had this to offer an hour ago:

You’ve seen this movie before and it typically ends the same way: the VIX spike invariably fades, and when the index sinks below the 10-day moving average that signals the spike is most likely in the rear-view mirror. That’s been the case many times since the start of 2015.

You’ll be forgiven if you think this feels surreal against the decidedly fraught policy and political backdrop.

But as you contemplate the apparent disconnect in what you think should be happening in terms of price action and what actually has and is happening, do recall the following from a piece out in June from Deutsche Bank’s Aleksandar Kocic:

Dissensus has emerged as a new paradigm — an absolute inability to form consensus across variety of contexts, accompanied with an onset of a breakdown of conventional frames of reference. So, what does one do when no decision can be made? Well, one waits. As a consequence, the market flows are slowing down and vol sellers emerging.

With that as the context, consider the following from a client note circulating today by Kocic:

Via Deutsche Bank

Despite all political turmoil of the last two weeks, markets remain surprisingly calm.

There seems to be very little risk premia in the markets, both in terms of volatility and the skew (across pretty much all developed markets).

Although this might appear slightly counterintuitive, given the severity of potential implications that could emerge from such political “crisis” (if it escalates), in our opinion, this is largely due to the fact that in the near term, these developments could amount at most to inability to produce consensus, and therefore, additional stalemate and status quo. In other words, the real battle is not to declare any short-term victories, but to secure a more favorable position for mid-term political battles.

Rates
These are the two snapshots (Mar & current) of the 3M10Y vol skew compared to the history of vol/rate data since. vol has declined in a rally.

Seen in a broader context of 5Y history, current skew is informative of the level of complacency in the rates market. It represents a lower bound of what we have seen. There is no extereme premium either in a rally or a sell off; it is the mildest version of what happened so far.

Equities
One would expect that this is only the rates story where half of the Trump trade is already unwound. There was a slight bleep in VIX, but nothing that would signal a turnaround in perception of risk.

In equities, where rally is uninterrupted, still in full swing, situation is qualitatively the same as in rates. The Figure is for the 3M SPX options with the Current and Mar snapshots of the skew.

Here, we note the additional repricing of the skew on both sides in the last 6M: a slightly more aggressive puts and less of an upside than before. However, regardless of that, the skew anticipates more benign outcome than anything we have seen in the past 5 years.

FX
In addition, there is practically nothing alarming in the FX skew, at least not in traditional channels like JPY which normally reacts to a possibility of risk off trade. The fig is the history of the JPYUSD risk reversals, which trade right in the middle of the historical range (downward spikes are brexit and US elections).

Calendars
Once again, this is all about the short term as the market complacency and gamma selling have ironed out all the risk premia. widening of the calendar spreads , though suggest that risks are not completely dismissed in the long run. The most recent correction in the SPX calendars is due to mini spike in equities gamma.