Yeah, so the short equity vol. trade blew the fuck right on up this week. Of course you know that. And if you’re a former big box retail logistics manager who traded in a sweet gig making the cigarette break schedule at Target for a career selling vol. in your pajamas, well then what can I say other than “I’m sorry, man.”
It’s not yet clear what this is ultimately going to mean for markets. There are lingering questions about the implications for the systematic/programmatic crowd and really, for damn near anything where vol. is an input. Remember what Citi said a couple of months back:
Trades and strategies which explicitly or implicitly rely on the low-vol environment continuing, are becoming more and more ubiquitous.
“We’re all in this together” – literally.
That said, this hasn’t bled over into other places where you might expect contagion. Places like Crossover spreads, for instance:
“Whereas in 2007 the trades which wreaked the most carnage on investors were long housing and long structured credit, the biggest pain in 2018 is being felt by those who are short structured volatility and those long crypto-currencies,” SocGen’s Kit Juckes writes on Wednesday morning, adding that fortunately, this “seems like a smaller and more eclectic crowd, which might provide some hope that the economic damage from the vol spike will be limited.” Here’s hoping, Kit.
The fact that, as Juckes notes, cryptocurrencies and the short vol. trade have been the big blow-ups in 2018, and the fact that the implosion of the VIX ETPs ended up spilling over into the underlying, harkens back to something Deutsche Bank warned about weeks ago: namely both short vol. and cryptocurrencies represent the “new frontier in risk-taking” and both are emblematic of a “tail wagging the dog” scenario.
Of course there’s no way to tell whether the concurrent collapse of Bitcoin has played a role in exacerbating equity weakness over the past seven sessions, but we’d be remiss not to mention that Deutsche explicitly warned that both cryptocurrencies and the short vol. trade might simultaneously implode with consequences for equities just days before things started to fall apart.
In any event, Juckes goes on to say that “the market’s addiction to low volatility may be even more severe than its addiction to low rates,” and that “a higher vol world is yen-friendly and FX high-yielder unfriendly.”
So take that for what it’s worth and good luck to Kuroda should this end up getting any worse.
Oh, and as far as the whole “addiction to low rates” – remember that the whole reason things started to come apart this month in the first place was the ongoing bond selloff. Now that the VIX ETP deck has been cleared, we’re going to be right back focusing on that.