Market participants need a narrative. We have to ascribe causality. It makes us feel more comfortable because the alternative entails admitting that on any given day, the flows driving markets aren’t amenable to a quick summary.
Because detailing the actual mechanics behind a given session’s price action requires a modicum of effort, and because those mechanics aren’t familiar to the layperson, the financial media resorts to boilerplate copy. “Stocks jumped after Jerome Powell said the US economy is expanding with enough force to withstand interest-rate hikes while pledging to be judicious in removing stimulus,” Bloomberg mused on Wednesday.
That was partially true, but as detailed here on too many occasions to count recently, the kind of wild oscillations witnessed in both equities and rates over the past several weeks are the product of modern market structure, positioning, impaired liquidity (which gets worse when volatility rises) and an ongoing exogenous shock.
It’s repetitive, I know. “Equities are exhausting, I hate to even write about them now, as I’m largely repeating myself,” Nomura’s Charlie McElligott said Wednesday, on the way to reiterating why it is things refuse to calm down.
Everyone’s a day-trader now. “YOLO” is everyone’s mantra. It’s that mentality, particularly as it manifests in trading short-dated options, that’s perpetuating what I’m fond of describing as a “dry kindling” environment.
“Dealers remain embedded in ‘short gamma, short delta’ dynamic [as] customers buying 0 day-to-expiry or weekly type downside optionality because of the tightening and risk-off environment which presses into down days,” Charlie wrote. If that stuff moves into the money, it’s quickly monetized. Then, as McElligott reiterated, it morphs into “short-dated upside / call-buying playing ‘long delta’ for a bounce, which sees other hedgers quick to cover and unwind into spot rallies.” Puts then bleed out, dealers cover their hedges, only for calls to then get monetized on rallies. Rinse and repeat.
That’s your daily roller coaster. That’s what you’re seeing with these large daily swings and the wide distribution of daily outcomes, which continues unabated (figure below).
And it’s not just Ukraine. As Charlie went on to say Wednesday, market participants have also realized that “the Fed is de facto short strangles.” The vaunted Fed put is struck well below spot due to the necessity of preserving a hawkish bent in the face of the highest inflation in a generation, but they’re also effectively selling OTM calls. “If the market were to push back anywhere close to prior highs, financial conditions ease and force the Fed to increase their ‘hawkish inflation’ rhetoric to tighten conditions and push real yields higher or less negative,” McElligott wrote.
Although buybacks and some resumption of vol-control buying are supportive, the environment is conducive to ongoing fireworks, especially given the totally unpredictable nature of the situation on the ground in Ukraine, the prospect of a Russian credit event and/or a plumbing issue in connection with the SWIFT bans and sanctions on the Russian central bank.
“This macro chop drives the intraday volatility chop when then creates a dynamic where traders are left with no choice but to ‘de-gross / VaR-down’ as both long- and short- books push through risk limits continually,” McElligott went on to say, adding that “brutally high absolute levels of Vol have increasingly made ‘dynamic hedging’ with futures a preferred play that everybody is seemingly doing, but by nature, this is a form of ‘synthetic short Gamma’ as traders short into down trades, and cover into rallies.”
If you’re looking to explain all the sundry “Whys?” associated with an equity market which refuses to act like anything other than a vehicle for daily and hourly speculation, the above is the real story.
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