From Doomsday To The Largest Cross-Asset Vol. Collapse Since ‘Whatever It Takes’

This time three months ago, everyone was pretty sure the financial universe was about to come to an end.

Ironically, it was that brush with catastrophe that paved the way for what has since become a lake placid environment across assets. The Q4 tumult forced the dovish pivot from the Fed as tighter financial conditions and wider credit spreads threatened to spillover into the real economy via a reversal of the vaunted “wealth effect” and potentially dire consequences for an already over-leveraged corporate sector, respectively.

At the same time, mounting evidence of slowing global growth catalyzed, at least in part anyway, by months of trade frictions, cemented the case not only for a Fed pause in January, but for a dramatic shift in forward guidance and an explicit acknowledgement that tweaks to balance sheet policy are in the cards.

Of course one “good” policy U-turn deserves another and so, in short order, virtually everyone fell in line. Before anybody knew what happened, risk assets surged anew, volatility collapsed and thanks to still-pressing questions about whether global growth has in fact bottomed, bonds remained en vogue. In other words: the QE trade was back.

Read more

Back To The New Status Quo.

‘They’re Coming For It’: QE Trade Spotted In The Wild As Lemmings Peer Over Cliff

The collapse in cross-asset volatility has been anchored by rates vol., which has ground steadily lower (to a record nadir) amid enhanced forward guidance and as market participants come to the realization that “lower for longer” may ultimately morph into “lower forever”.

Just how dramatic has the collapse in volatility been? Well, pretty dramatic actually. In fact, as BofAML notes on Tuesday, “the pause in the Fed’s monetary policy tightening cycle has contributed to one of the strongest declines in cross-asset vol in recent years.”

(BofAML)

The synchronized decline in volatilities and credit spreads which has unfolded over the last two months hasn’t been seen since 2014, the bank goes on to write, before marveling that “the fall in cross-asset vol has been the largest since Draghi’s 2012 ‘whatever it takes’ comments”.

(BofAML)

At some point, given ostensible capacity constraints on DM monetary policy (i.e., rates just off the lower bound at best and still mired in NIRP at worst and balance sheets still bloated), one assumes a “policy impotence” trade will emerge. But as we’ve been keen to note over the past two weeks, that trade is a tricky one, because as Deutsche Bank’s Kocic wrote back in 2017 at the height of the short vol./carry bubble, “to facilitate a change, there have to be multiple concessions to those forces against which change is directed – you can say no, but it is inconsequential.”

In the meantime, central banks again emerge as the most powerful force when it comes to pushing vol. lower.

“The important lesson is that while there are many factors that can drive volatility lower (e.g., low macro vol, strong growth/earnings, share buybacks, option-selling for yield, etc.), central bank policy and rhetoric clearly remain more relevant than ever”, BofAML writes, in the same note cited above.

What now? Well, for their part, BofAML doesn’t necessarily see a return to the 2017 lows for equity vol., but they think FX and commodities vols may well grind lower.

The bank notes that using the measure graphed in Chart 7 above (i.e., the average z-score across equity imp. vol., interest rates imp. vol. , FX imp. vol., commodity imp. vol., and credit spreads), the drop from the January 3 highs to recent lows is “~2/3rds as large as the cumulative fall witnessed during the 2014 episode.”

What’s more notable, though, is the speed of the collapse. As Chart 8 above illustrates, “in 2014 it took about 4 months to reach similar levels from a comparable starting point, while this time around it has taken just over 2 months”, BofA goes on to point out.

Next, they reiterate that rates vol. is the anchor and regular readers know we’ve spent a ton of time talking about suppressed rates vol. over the past six months.

Read more

The Central Bank Put Is Still There, But ‘Politicians’ Implied Vol. Has Exploded

‘Recessions Used To Be Exciting’: Deutsche’s Kocic Asks If It’s Finally Time To Own Volatility

Seeing Red And The Indefinite Suppression Of Rates Volatility

“The recent decline in x-asset vol can be viewed as other asset vols recoupling with the least stressed component”, BofA continues, on the way to suggesting that “the extent to which rates vol has decoupled today is historically stretched and unlikely to last.”

(BofAML)

Assuming rates vol. remains depressed indefinitely (and those who want to read more about why that will probably be the case are encouraged to peruse the “Indefinite Suppression” post linked above), the recoupling of cross-asset vol. should take the form of other vols falling. If you’re BofA, you think FX and commodities vol. will be “the next shoes to drop”. To wit:

Drawing from the 2014 episode, it is instructive to note that after an initial drop, equity vol and credit spreads managed to not fall to the same depths as commodity vol while it was FX and rates vol that ultimately recoupled from above. This is consistent with the historical lead-lag relationship between rates vol and the volatility of other major asset classes. Chart 13 shows that, since 2007, rates vol has had a higher correlation to future FX and commodity vol than to future equity and credit vol. In other words, the level of rates vol today is a better predictor of future vol in FX and commodities (the more macro-driven assets) than in equity and credit.

What, ultimately, does this mean for those looking to place an early bet on “policy impotence” or to otherwise wager on a cross-asset volatility spike?

At the risk of lapsing into tautologies, it means don’t bet on it, because as BofA writes in the final paragraph of the section from which the above excerpts are pulled, a sustainable rise in cross-asset vol. likely needs a vol. spike in the asset where volatility is most depressed, which in this case is rates.

As of right now, that looks like a far-fetched proposition.