japan nikkei yen

What Caused Japan’s Mini-Volatility Shock?

All's well that ends well in Japan after a six-day slide. Or maybe not.

All’s well that ends well in Japan after a six-day slide. Or maybe not.

The Nikkei rebounded on Thursday, rising 1.5% and snapping a rout that encompassed a rather disconcerting episode of volatility that unfolded during last Thursday’s session.

If you recall, things suddenly went to pieces a week ago when, after rising in the morning, the bottom abruptly fell out for the Nikkei. Thanks to the morning gains and a bit of afternoon dip buying, the benchmark only closed lower by 0.2%, but it was the rapidity of the decline from the intraday highs that caused concern. We detailed that hours after it happened here.


Quite a few folks noted that the move was at least partially attributable to people making “adjustments” ahead of futures and options settlements last Friday. And of course the old yen-equities chicken-egg scenario was at play, with USDJPY diving in tandem with Japanese equities.

For their part, Deutsche Bank thinks you should at least consider the possibility that what we saw last Thursday was a preview of what happens when the vol.-targeting crowd starts to deleverage into a falling market. This is a manifestation of the “doom loop.”

“We don’t think that risk parity funds (which have small balances) and variable annuities supplied to individuals conducted large-scale selling on 9 November because of their low leverage,” Deutsche writes, in a note documenting what happened in Japan last week.

“However, increase in stock (or stock and bond) volatility might trigger position cutbacks when hedge funds, CTAs, and others engage in trading with higher leverage,” the bank goes on to note, adding that “in fact, stocks and bonds weakened from about 13:20 in the Japanese market on 9 November.”


This Thursday (i.e. today), DB is out noting that Japanese equities have now largely returned to model, but it bears repeating that volatility is becoming more important as a driver of the action in a market where US equities, interest rates, and FX are the key determinants.

“Funds with volatility targeting strategy are growing to the largest ever,” Deutsche cautions, before stating the obvious which by virtue of being obvious wouldn’t be worth stating if it weren’t for the fact that no one seems to be listening:

If the influence of such funds expands, the buying pressure on risk assets would increase in low volatility phase, and the selling pressure would increase in high volatility phase.

Make no mistake, this kind of thing is going to keep happening, both at home and abroad. And don’t forget, CTAs’ beta to the S&P is now sitting near the top of its three-year range.


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