It’s been a roller coaster of a quarter and I don’t think that was something most people expected.
After all, 2018 (or at least H1) was supposed to be more of the same in terms of synchronized global growth and still-subdued inflation. More “Goldilocks” please.
But all of that changed towards the end of January when the narrative around rate rise abruptly shifted as investors stopped viewing rising rates in the U.S. as a barometer for the robustness of the recovery and instead took the rapidity of the back up in yields as a warning sign. The briskest y/y wage growth since 2009 that came along with the January jobs report started tipping dominos and before you know it, the VIX had its largest one-day spike in history, the short vol. products were blowing up, CTAs and risk parity were de-risking, and global equities were in a correction.
No sooner had we dug ourselves out of that hole, than a certain “very stable genius” started a “hot” trade war with the Chinese and between that and the ongoing staff shakeups at the White House, we were all thusly fucked again. Then came the tech selloff. Oh, and LIBOR is back.
The only saving grace over the past could of weeks has been the extent to which the risk-off narrative has underpinned Treasurys, making the dreaded 3% on 10s seem like a pipe dream for the time being and indeed, rates look the least vulnerable. Here’s 3M10Y rates vol against a model that incorporates IG credit spreads, curve risk premium, FX vol and rate levels:
So vol. is being pushed away from rates most recently, but as you can see, we seem to have broken the low vol. spell in 2018 across assets. Rates vol. could return if central banks make a communications “error” or if inflation expectations become untethered for whatever reason.
With all of that in mind, consider the following from Bloomberg’s Garfield Reynolds who thinks you should “enjoy those chocolates” – because next quarter could be just as trying as this one turned out to be.
Risk assets look to be in dire need of the Easter break because the second quarter has every chance of being more stressful than the first.
- Volatility across bonds, FX and stocks is soaring. This quarter’s jump in implied vol is the most since the European debt crisis escalated in 2011 and it’s the sort of steep shift only seen on two prior occasions: the LTCM meltdown of 1998 and the Lehman-led crash of 2008
- Actual volatility is also exploding, with the U.S. benchmark leading the way for the first time since 2008 too. Oh, and the 206% surge in 90-day realized volatility for the S&P 500 has only been topped twice, in 1987 and 1930
- The market turmoil has been greeted with some bemusement due to the lack of an obvious real-world reason. “The fundamentals are still strong” is the catchcry. But the jump in volatility is in itself the key fundamental change
- It has fueled broader risk aversion, helping to explain why the MSCI All-World Index of global stocks is poised to snap a seven-quarter winning streak – – its longest stretch of gains since 1997 — and global bonds are set for their first decline in currency-neutral terms since 2016
- There are signs that it’s correct to be pricing in a marked deterioration from 2017’s perfect low-volatility rally. Global data is breaking down too fast for economists to keep up. Both Westpac’s data pulse index, which tracks outcomes relative to prior reports, and Citigroup’s surprise gauge are rapidly heading south
- The worst for markets is yet to come:
- The S&P 500 has yet to really break down — the longer it holds above the 200-day moving average, the bigger the crash will likely be when it happens
- WTI has again failed to hold above $65, forming a very ominous double top that must make the near- record net longs for WTI nervous. With U.S. output surging, and sliding commodities signaling a slowdown in demand for raw materials, the stars are aligning for a big, disinflationary step down by crude
- Treasury 10-year yields have had to be dragged down kicking-and-screaming because the Fed is sticking to its dots, but the latest capitulation of the term premium forewarns of a larger collapse in rates
- When they do, that will cast doubt on the Fed’s guidance and spread a fresh wave of disruption across assets that will start out in bonds, currently less volatile than FX and stocks relative to historical norms
- So, rest up and enjoy those chocolates