One Chart Shows All The Ways A Fed Hike Could Create (Fleeting) Bouts Of Volatility

Clearly, pervasive geopolitical turmoil and utter chaos on the domestic policy front are not enough to budge volatility.

The disconnect between market-based measures of vol. and the best available means we have for quantifying policy/political uncertainty is the story of the year. The reasons for this disconnect have been documented, discussed, and otherwise debated ad nauseam and you can believe the fixation will continue right up until there’s a vol. spike that proves sustainable enough to satisfy those who spend their days decrying markets’ apparent complacency.

The controlling factor here is the communication loop between markets and central banks. The removal of the “fourth wall” and the radical transparency that comes with allowing markets to essentially co-write the policy script have made it impossible for anyone to take a long-term view. Only the rebuilding of that wall will be sufficient to break the spell – as it were. You can read more about that in the following recent posts:

Given that, and given how passive flows operate within that loop to supercharge “bad” behavior, it’s likely that former trader Richard Breslow’s “bold” prediction (see here) of an epochal shift in the landscape will not in fact play out.

All of the above explains why a Kevin Warsh-led Fed is about the only thing that truly threatens to upend the prevailing dynamic. If you haven’t read up on that, please do in “‘Volatility Would Return With A Vengeance’: Kocic Warns On Warsh And The Rebuilding Of The Fourth Wall.”

With all of that said, introducing Fed hikes does have the potential to create fleeting bouts of cross-asset volatility via a number of channels. There is, for instance, the possibility that a stronger dollar could lead to an unwind of carry trades or otherwise destabilize emerging markets. And on, and on.

Well, for those interested, we thought we’d roll back out the following graphic from Deutsche Bank’s Aleksandar Kocic originally published in 2015, but just as relevant now as then, for obvious reasons.

You should start from the bottom left-hand corner and work your way through the various scenarios.

FedHikesVol

(Deutsche Bank)

Again, in the absence of a true sea change, any episodes of volatility that manifest themselves as outlined above are likely to be transient. Unless of course this guy somehow gets the nod and actually “walks the walk”…

Warsh

 

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