Citi's Steven Englander On Black Swan Fatigue, And Why It Is Time To Hedge Tail Risk Again

Tyler Durden's picture

From Citi's Steven Englander

Black Swan Fatigue and Under-Provisioning for Fat Tails

Tomorrow is the second anniversary of the S&P having begun its rebound from its cycle low (see the figure below)

We also see historical (and in some cases implied) volatility in many currency pairs at post-crisis lows (see chart below). We plot 1-month realized AUDJPY vol below because it is typically a metaphor for high volatility, but even this cross appears tame. A similar pattern is reflected in many G10 currency crosses.

Where do the Black Swans comes in? For much of this two year period of S&P recovery, the clever thinking among investors has been to  fade the rebound. This is as much true of FX investors as in other classes. Generically, the arguments have been that the forces driving the recovery are fragile, that many fundamental issues in global financial markets are unresolved, and that policymakers have deferred rather than resolved problems.
It's hard to argue with this line of analysis except that it has been dead wrong in market terms. Our conjecture is that investors are tired of being told to hedge against risks that have not emerged, and where the positions end up as costly in terms of premium paid out. (And it is an obvious truth that the kids outside playing in the snow without sweaters and scarves seemed to have much more fun than those of us who were bundled up.) Indeed the downward trend in vol may reflect that too much optionality was bought to hedge risks that didn't happen and now it is being disgorged back into the market.
In recent weeks we have been arguing that tail risk remains and is unusually realistic given the potential sources of shocks. We have also found that in many cases clients are reluctant to buy into these fat tail scenarios (actually 'reject' may more accurate than ' are reluctant' ). The argument is basically that they have heard it many times before in the last two years and asset markets have continued to flourish.
We would argue that the correct approach is to ask whether the macro risks looking ahead are those that can be dealt with using the policy tools at hand. If not, the tail risk scenarios are more concrete. Conversely if the asset market bounce and rebound in high-beta currencies over the last two years can be explained largely as the result of massive liquidity injections globally and significant fiscal policy ease, the question looking ahead is whether these policy tools will be equally effective in dealing with the future shocks.
Consider the obvious potential risks: an oil shock, commodity prices and advancing headline inflation in the context of growing concerns about social and political disruption. We would make the case that the risk is high that if any of these shocks were to move to centre stage, it would be harder for policy makers to deal with them because printing and spending money is not quite the solution to these problems that it was to the financial shock of late 2008 and early 2009.
… which brings us back to Black Swan fatigue. When we see currency vols so cheap in a world that appears to be so risky and in which policymakers do not hold a terribly strong hand, it makes a strong case for hedging tail risk, even if FX price action is apparently indicating otherwise.

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rubearish10's picture

Yes and once you've committed to tail risk management, you cannot and likely should not stop, until your investment thesis/activity has ended. This should be done no matter what the cost, as long as you don't go broke doing it, harr harr.

kaiserhoff's picture

Good point, and it does cost, but put spreads are fer cheap if you do your homework.  They also help you sleep at night;)

rubearish10's picture

HR, very important, no doubt. Time is major factor. Big first mistake is to not buy enough (time). In other words, roll forward deep, barbell and participate in upside with whatever "carry asset" you prefer etc....Been sleeping well lately, thanks.

Snidley Whipsnae's picture

The Fed has a hammer and everything looks like a nail to them... the one trick pony will continue to print even if it solves nothing.

Scottj88's picture

Its all rigged...

We have treasonous bankers running our system...

Oil, Silver, Gold all going to be rising and especially food prices.  America will be like all other countries, and we will revolt... not by choice but by neccessity.

ZeroPower's picture

i.e. Hedge your long CHF long CAD and...even, gasp, long EUR positions.

Misean's picture

It's taking longer for the banksters to get the rube's watching them play 3 card monty to ante up.

dick cheneys ghost's picture

US ask Saudi's to arm Libya's Guerrillas......



and congrats to Zero Hedge on time mags list on best financial blogs..,29569,2057116,00.html

Arch Duke Ferdinand's picture

""US ask Saudi's to arm Libya's Guerrillas......"'


Single best way to win a revolution?

...Starve the Government...

Henry Chinaski's picture

It is impossible to starve government if the FED exists to print money an buy debt.  That's why the goverment will never willingly return to a gold standard.  If people had to pay for government out of pocket, things would be different.

sschu's picture

If people had to pay for government out of pocket, things would be different.

This is so true.  While we rail against the Fed, and deservedly so, it is likewise the Federal Government that deserves our wrath and focus.  The Fed and the government are mutual addicts and enablers, each feeding the other's habit.  They are co-dependents and must simultaneously be brought under control. 

They will fight to their destruction before giving up, the battle is not even begun. 


Snidley Whipsnae's picture

I second the congrats to Zero Hedge for all their fine reporting. If not for them and a very, very few other sites we would all be dancing in the dark. Hat tip!

kaiserhoff's picture

Well said, and not an easy pace.  None of us has complained about a slow news day in a coon's age.  No offence, Rocky.  We all know you are a spring chicken at heart.

IQ 145's picture

 An environment in which hedging the black swan type future has become unpopular, is exactly the environment in which you want to be spending money on cheap Puts.

Snidley Whipsnae's picture

Compliments of Jesse...

"The weakness with this US Dollar DX index is that it is highly weighted to the developed economies of Europe and Japan. As such it may not reflect erosion of dollar purchasing power vis a vis the BRICs, and external measures such as gold, oil, and silver. It may be masked by the mutual weakness of central banks all inflating their currencies in unison."


"Rather than rallies through economic vitality and recovery, the dollar rallies have been marked by relative declines primarily in the euro on their sovereign debt problems. It is almost like a couple of drunks leaning on each other for support, except that the US is picking the Eurozone's pockets while they do it."

Remainder of comments here...

Sokhmate's picture

"Black Swan Fatigue" LOL. ZHers should seriously consider creating a 'ZH' terms dictionary.

Anaxagoras's picture

Tonight's Movie:

Dr. StrangeBen, or: How I Learned to Stop Worrying and Love Inflation

buzzard beak's picture

Look out for my upcoming book, "Black Crow: The Mystification of the Thoroughly Mundane"


KickIce's picture

Black Swan morphs into dying duck.

rd's picture

Occam's razor: Moral Hazard! Thank you Mr BB.

lsjcma's picture

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Grand Supercycle's picture

Despite market intervention/QE - natural market forces can not be stopped – only delayed.

When the market does reassert control – the reaction (the overdue correction) may be even more extreme due to that delay.

And some may erroneously refer to this as a Black Swan since it’s ‘unexpected’.

However they will be wrong because major market events can be predicted by some analysts.

trendybull459's picture

We need your help,come to us and make your voting:

tell it to friend,we need to rich every interesting one to make his vote for FED existence