central banks ECB volatility

Suspension Of Disbelief And ‘The Largest Vol Seller In The Market’

Suspension of disbelief, on the other hand, implies an active effort on the part of the person or persons in question to avoid common sense in favor of a more convenient explanation of reality.

At a certain point, you can’t fix stupid. But even more intractable, almost by definition, is suspension of disbelief.

“Stupid” isn’t always deliberate. Indeed, inherent in the idea of stupidity is that someone isn’t truly capable of understanding something. Suspension of disbelief, on the other hand, implies an active effort on the part of the person or persons in question to avoid common sense in favor of a more convenient explanation of reality. Often, that explanation is akin to confirmation bias. When you suspend disbelief you are very often engaged in a mental effort to avoid something that’s psychologically uncomfortable.

In markets, that suspension of disbelief manifests itself in an effort on the part of pundits and retail investors to pretend that the following chart is a coincidence:


The idea that $14 trillion in liquidity has driven up prices for risk assets is common sense. And not only that, the people who injected that liquidity explicitly stated that they intended to drive investors down the quality ladder and out the risk curve. But admitting that is uncomfortable for a lot of people. Not because it makes their paper gains any less “real” – but rather because it suggests that they are not any smarter than they were pre-crisis.

And see that’s how insidious suspension of disbelief can become. Psychological comfort overwhelms even the profit motive. Admitting that your gains are a product of central bank largesse does not make those gains any less real (and let’s just avoid the argument about whether all of that money printing has in fact made fiat money less valuable – that’s for another time). You can still cash out those gains while admitting that they emanated from something that had nothing to do with your own investing acumen.

But that’s no longer good enough for people. Because locking in gains now, ahead of the wind down of global stimulus, is a tacit admission that you believe that wind down will imperil those gains. Well if you tacitly admit that, then you have simultaneously admitted that those gains were handed to you on a silver platter by central banks.

Rather than admit that, take your money and run, people are now going to literally push their chips. Whether these folks realize it or not, what they’re doing is hoping to have their cake and eat it too. Because if you stick around after the stimulus unwind gets underway in earnest and risk assets continue to rise, well then you can claim it was never stimulus that led to your gains in the first place – you can claim that you are both rich and smart.

The obvious risk there is that when the tightening does get underway in earnest, risk assets fall and you lose some of your gains. Then you’re in the worst case scenario: you’re less rich and you’ve been proven to be stupid.

Central banks realize this is going on. And so, in an effort to keep you solvent, they maintain the communication channel and allow you to be a co-author of the policy script. That was on full display late last month when the ECB committed to keeping QE in place through next September (and likely through the end of 2018) while also preserving the “well past” language in the statement. That “well past” language effectively ensures there will be no rate hikes until “well” into 2019.

If you’ve followed our discussions of this in the past, you know that as long as this two-way communication channel between policymakers and markets is preserved, vol. cannot sustain a bid.

In a new note, BofAML is out reinforcing that notion in the context of the ECB. One of the things the bank’s Barnaby Martin has long pointed to is the persistence of CSPP (corporate bond buying) even as PSPP is tapered. Additionally, Martin has variously (and correctly) characterized central banks as vol. sellers both through word and deed. The dovish bow Draghi put on the taper announcement only underscores that thesis. Consider this from a new note:

The last ECB meeting proved our thesis: CBs are the largest vol seller in the market and rates vol is key for credit. Despite the ECB announcement of its intention to halve the pace of QE in 2018, it also committed to rates remaining at record low levels well past the scheme’s end. In simple terms, Draghi delivered another dovish taper, similar to the December meeting a year ago. As a reminder, during last December meeting, despite the ECB announcing the reduction of the pace of the QE program from €80bn down to €60 billion per month, implied vols moved lower, as a hawkish action was coated with a dovish message.

Indeed. And by continuing to provide dovish guidance while simultaneously distorting supply/demand dynamics in the credit market, the ECB can continue to manage volatility or, more colloquially, foster the BTFD mentality. To wit, from BofAML again:

The ECB forward-guiding the market for a hike well after the end of the QE program, means that the first “technical” rates hike will be well into 2019. This buys more time for the bull market, we think.

Additionally, it further reinforces our view that the market will continue to operate in a “buy-the-dip mentality”, especially as there is scope for the CSPP to remain strong well into the tapering phase of 2018. Note that the CSPP buying pace is only slightly lower compared to the pace it started 18 months ago, despite tapering from €80bn to €60bn last April (chart 2).


Scarcity of bonds will remain a key tailwind for spreads and credit vols, on the back of too much money chasing fewer bonds.

So you are probably safe – for now. But don’t fall into the trap of confusing central bank generosity (in the form of tacit vol. selling and an unwavering desire to push the moment of reckoning even further out) for your own investing acumen.

Don’t let pride get in the way of locking in gains. Because at the end of the day, there’s nothing “stupid” about taking some off the table after participating in one of the longest running bull markets in history.


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