Impeachment, world wars, pandemics – lions, tigers, bears – it hasn’t mattered for a market surfing a wave of central bank liquidity.
Of course, balance sheet expansion and rate cuts aren’t the only things keeping stocks buoyant and volatility suppressed. There are at least four key factors at play, one of which is the overhang from option flows.
With risk assets seemingly on the mend after a shaky Tuesday, Nomura’s Charlie McElligott notes that although “we did see some of the ‘extreme’ $Gamma and $Delta ‘drop-off’ after last week’s expiry… enough was rolled out and up to maintain ‘still extreme’ historic percentiles [with] $Gamma still 88th %ile since 2014 [and] $Delta still 96th %ile”.
(Nomura)
Last week, Charlie noted that more than a third of the total $Gamma across strikes was set to drop off following expiry. Had that not been rolled, it could have unshackled the market, allowing for larger directional moves. What the above visuals suggest is that the vol-dampening effect is still in in place – that dealers’ gamma profile is still long and should thereby help keep things anchored.
That’s good news at a time when the market is clearly susceptible to virus headlines. Effectively, the above is a circuit-breaker that will keep sudden downdrafts from tipping dominoes – downdrafts like we saw briefly on Tuesday, when CNN tipped the first US case of the Wuhan virus.
But wait, there’s more.
McElligott also emphasizes that the Fed’s T-bill buying and clear preference for keeping rates on hold barring some manner of unthinkable upside inflation shock should anchor rates vol., which in turn serves to compress volatility across assets.
“As long as Rate Vol remains suppressed thanks to Fed ‘forever unchanged” forward guidance and POMOs / asset-purchases in order to maintain ‘ample reserves’, we too should expect that cross-asset vols too will stay lower”, he writes.
(BBG, Nomura)
That cross-asset vol. suppression means the market remains in “carry/momentum” mode.
As shown in the visual on the right, all major markets tracked in McElligott’s CTA model estimates are “at + or — ‘100%’ signals across the board, which then allows for more leverage to be deployed into the positions / larger gross exposures”.
Again, this is all good news at a time when the next Wuhan headline has the potential to throw markets for a loop.
The title of Charlie’s Wednesday note: “Down with disease”.
