This page has been archived and commenting is disabled.
Morgan Stanley Expects QE2 Announcement Next Week, Takes Other Side Of Goldman's "Variance Swap" Trade
Exactly a week from today, the FOMC will meet on September 21, to decide whether or not to go from QE Lite to a full-blown QE 2 regime. And while most pundits had previously lost hope that the Fed will go full retard in its dollar destruction ways as early as next week, instead opting for the November 2 meeting if not wait for 2011 entirely, Morgan Stanley (specifically Jim Caron) came along: "We see considerable risk that the Fed may open the door to QE2 at this September 21 meeting despite the stronger-than-expected August payroll results and even if upcoming economic data stabilize. We believe that QE2 may come in the form of a vague outline for a plan to buy assets, expand its balance sheet and keep interest rates low conditioned upon economic data." Why the sudden change in opinion? "We believe that the Fed may be reluctant to act aggressively after September 21 so as not to influence the election outcome. However, if deterioration in economic conditions warranted it, then the Fed may uncharacteristically act close to the election date. Acting sooner rather than later would be consistent with Bernanke’s plan to stave off deflation risks before they arise." Right or wrong about the Fed's choice (and with Caron's recent track record, one may be tempted to choose the latter), Morgan Stanley does correctly observe that volatility will likely jump in the weeks and months ahead, even as its has been moving progressively higher lately: "Interest rates have been subject to big daily swings." Curiously, as a hedge to surging rates vol, Morgan Stanley proposes the opposite Variance Swap trade that caused a massive loss for Goldman in Q2, and was Goldman's Top trade of 2010. Let's see who blows up first: Goldman, which still expects a decline in vol, or Morgan Stanley who is on the other side. Perhaps the two firms can just trade with each other (that wouldn't be that much of a change from the current regime).
Rising Volatility in the Months Ahead – Consider the Source
Let's start with policy and economic uncertainty – the Fed may open the door to QE2 at the September 21 FOMC meeting. The September 21 FOMC meeting will be the last Fed meeting until the next meeting on November 3 after the mid-term elections on November 2. Based on Bernanke’s Jackson Hole speech, many investors thought this would be the opportune time for the Fed to introduce QE2, a proposition for the Fed to buy more assets and drive interest rates lower. That is until the stronger-than-expected release of the August payrolls caused investors to reassess their thinking and postpone their expectations for QE2 until a later date. We see considerable risk that the Fed may open the door to QE2 at this September 21 meeting despite the stronger-than-expected August payroll results and even if upcoming economic data stabilize. We believe that QE2 may come in the form of a vague outline for a plan to buy assets, expand its balance sheet and keep interest rates low conditioned upon economic data. Why the rush? We believe that the Fed may be reluctant to act aggressively after September 21 so as not to influence the election outcome. However, if deterioration in economic conditions warranted it, then the Fed may uncharacteristically act close to the election date. Acting sooner rather than later would be consistent with Bernanke’s plan to stave off deflation risks before they arise. We believe this to be a considerable risk which supports our view for higher volatility in the weeks and months ahead.Finally, political uncertainty. The gridlock in Washington over the appropriate fiscal response and stimulus to boost the economy creates a wide range of outcomes for the path of interest rates. For example, our economics team has a bimodal and asymmetric outlook for yields (see Will 'Sunset' Darken the Outlook, September 3, 2010, Berner and Greenlaw). Specifically, if the Bush tax cuts are not extended, then it would cause a fiscal drag on growth that could shave off 3/4% of 2011 growth, according to our US economists. Under such circumstances, we could see UST 10y yields falling to 2% or lower. However, if the tax cuts are extended and there is a break in the fiscal policy logjam, as our base case suggests, then this may encourage economic stability that could push UST 10y yields well north of 3%. As a result, we expect many wide swings in interest rates as we head into the politically charged period of mid-term elections on November 2 and the December 31 sunset of the Bush tax cuts. In our view, the wide bimodal path of rates, due to political and economic uncertainty, is the reason for vol to move higher in the months ahead.
Here is how MS suggests positioning for the gradual increase in Vol.
Expressing a Long Volatility Position
Thus, we expect volatility to rise during this period and recommend that investors manage their volatility exposure while investing in carry products. We re-iterate our favored ways to own volatility is through variance swaps and forward-volatility agreements (FVAs). The risk to these trades is that vol remains low.
Variance swap: A variance swap gives investors exposure to realized volatility over the life of the swap. Investors are taking a view on current implied volatility versus future realized volatility. As Exhibit 1 illustrates, the low level of rates does not tell the whole story; the market is rife with debate that is producing a high frequency of double-digit basis point moves in 10y rates, which is contributing to the rise in volatility. In a variance swap one gets the square of the move in rates, which is beneficial when the market is frequently having big swings.
- Buy 3-month variance swap on 10y CMS struck at 131 variance points. This is equivalent to 114bp normal vol, or 7.2bp/day breakeven. Over the past month, realized vol has outperformed implied vol, and we believe that may be the case going forward, given the policy, economic and political uncertainty.
Forward-volatility agreement (FVA): An FVA gives investors exposure to the level of implied volatility at a set forward date. Investors are taking a view on future implied volatility versus what is priced in by the market. We expect realized volatility to rise over the coming months as it typically leads implied vol, which we think is at an attractive entry point. An FVA enables one to cleanly express a rise in implied volatility that is independent of the level of rates and strike.
- Our preferred expression of this trade is to buy a 3-month forward 3m10y FVA for 380bp. This means that the investor has agreed to buy an ATM 3m10y straddle in 3 months for 107bp (see Exhibit 2, LHS).
Heavy Supply and High Correlations to Interest Rates May Increase Volatility in the Rates Market
The heavy supply calendar for September may act to exacerbate movements in the interest rate markets. In addition to the $127 billion UST supply, we also have estimated investment grade corporate issuance at close to $100 billion this month with only about $25 billion maturing, which puts net issuance at ~$75 billion for IG corporates (see Exhibit 2, RHS). Issuance matters more in terms of interest rate risk because the duration of issuance has been increasingly making the heavy bond supply more sensitive to changes in the level of interest rates. This is a point we have made in the past, but the interest rate risk is exacerbated today due to the spike in issuance. For example, in August, 39% of corporate issuance had maturities greater than 10 years, the most since December 2007 based on Bloomberg data. Also, Bank of America Merrill Lynch indices show that the duration of corporate bonds reached a record high of 5.69 years. As investors reach for yield further out the yield curve, they are also upping the ante on their interest rate risk exposure. It seems that many asset classes, whether bonds or stocks, are highly correlated to the level of interest rates. This makes the volatility we expect in the interest rate markets in the next few months all the more worrisome.
Conclusion: Policy, economic and political uncertainty may cause rate volatility to rise in the months ahead. Much hinges upon the extension of the Bush tax cuts by the end of the year. Failure to extend these tax cuts might shave ¾% off of 2011 growth and alter its path (see Exhibit 3). This will have a meaningful impact on the path of interest rates as well. A failure to extend the Bush tax cuts could create fiscal drag and cause UST 10y yields to drop below 2%, while an extension of the tax cuts could push yields well north of 3%. This produces a bimodal distribution of rates that is causing interest rates to fluctuate greatly in the interim period. Managing this rise in volatility while earning carry will be the key to adding alpha. In this report we will discuss various ways to gain exposure to volatility.
»
- 10256 reads
- Printer-friendly version
- Send to friend
- advertisements -
Huh, the FED doesn't want to influence the election? C'mon, they want Obama and the hapless incumbents of either party to continue to hand them the keys to the country. Geithner, Frank, Obama, Bernanke, Dodd, Pelosi- this is a bankster's wet dream after Bush and Paulson set the stage for the takeover.
I don't mind another round of stimulus on all my gold / silver investment. Come on do it, Benron. I know you cannot hold it off.
Still with LBMA's naked-short @$$ on fire as all the actions going on @ CRIMEX lately, I doubt they'd do a QE2 right next week to pour more gasoline on the fire.
Watch silver go up anyway; it's starting its long march up to close the ratio gap.
the Fed will go full retard
Zerohedge rocks!
"Let's see who blows up first: Goldman, which still expects a decline in vol, or Morgan Stanley who is on the other side".
Decline in Vol = Increase in Retard Market Intervention ( RMI ) .... Who wants to take the other side of that?
There's a problem. Unlike QE1, with QE2 there's a serious concern about inflation. Or, to be more precise, the Fed is concerned about the inflation component of BIflation. Yes, they're concerned about down spiraling real estate, contracting consumer credit and weak discretionary spending. And Yes, they're concerned about agflation and boom-time oil price levels.
The side-effects of QE can be pernicious and hard to control. I think they'll wait this one out, do another round of jawboning, and leave an open an option for more QE if needed.
Agree. The EM's are screaming about food inflation. Gasoline riot/protest in India last month. 3.5% ++ inflation in China, led by what 7% food inflation. Talk of another food crisis with Russia wheat export ban.
I think they have the eco data cover to hold off. QE II might even spook the market by suggesting more is wrong then considered. More consensus now on no double dip. Buffett even said so.
No one is asking for it right now. And stealth QE Ia working fine. They will have to hold off...
A shot of speed on Sept. 21 works for the political agenda. The negative consequences won't be appearent to J6P until just about the first Tuesday in November.
Anyone want to have suggestions for buying calls on silver?
Stop talking about the trash statistics from China. The Chinese government has been manipulating data for years. The real CPI is more than 10%!!!
By the way, if you wanna invest in agri, you may choose cotton, which has the strongest fundamentals among all...
We take a case of viagra and EM gets a woody or is it woodie...blah hahaha
No coincidence that the Fed is waiting for the PPI and CPI numbers this week. If we get below .5% on an annual rate, with the spectre of deflation before years' end, Fed may press the red button, my finger will be on ABX, NEM, NG...
Uh, isn't MS, like, always wrong?
In forecasting the consequences of current economic policy, many pundits are downplaying the risks associated with the surging national debt and the rapid expansion of marketable Treasury securities. Their comfort stems from the belief that a staggering debt burden will be manageable as long as interest rates remain extremely low; and, as they believe the Fed is in complete control of setting rates across the yield curve, they see no danger of rates ever rising past the point of comfort. Those who subscribe to this fairy tale forget that, in real life, there are many more hands on the interest rate steering wheel.
http://www.europac.net/commentaries/does_fed_ultimately_control_interest...
So the market goes up on the expectation that fraud, lies and deception are all set to continue?
"So the market goes up on the expectation that fraud, lies and deception are all set to continue"?
Up, down, and sideways ... Fraud, lies, and deception = The "Market"
That's really useful and thanks for sharing. Ugg boots canada provide genuine ugg sheepskin boots at the lowest of prices. You can find the trendy styles and perfect comfort ugg boots at here.
I may have to eat my words, but I dont think the Fed will do QE2 at least until after the elections, and probably not until 2011.
If the Fed does QE2 right now, with the price of gold, silver, food, and many commodities near its maximum... it could be a big hit for the dollar. I think he will wait until the deflationary correction brings prices down for a while, scare people with deflation propaganda for a while, and then it will do QE2 (aborting the deflationary correction, and bringing on the beginning of strong inflation).
That's the problem. Gold, silver, food, oil won't go down and will keep rising.
They should realize it's not a waiting game. One of those turkeys will need to stick out his neck and he'll lose his head for sure. But it will be for the greater good.
There's no more patriotism...
Do you realize that QE2 right now could start a run on the dollar?
I think that if the Fed does nothing the deflationary correction will come back, and gold, silver, food, oil will go down.
Also, QE wont solve the crisis, it will just keep the unproductive companies alive, actually hurting the economy, even if it makes some indicators go up.
If they wait until the 21 it's going to be to late. I even think now is already to late. After option expiration, we'll lose another big number of retail investors that won't come back.
After every option expiration the number dropped and now we're getting on ridiculous low interest numbers.
I expected it 2 weeks ago, while they still had a window of opportunity. Timing is everything and the deadline passed a long time ago.
Like I said last time, the longer they wait the more expensive it gets. And the more the market is being rigged, the less people have a appetite to go back in. And that's not something you can change anytime soon. It will take years before the common man will trust the markets again if ever...
Never thought I would see a point in our history where the very foundation of our economic structure hinged on what the Fed does or does not do...
Morgan Stanley, GS, Blackstone, JPM are all "jonesing" for more free money...if the Fed does institute QE2 then they will no longer be a neccessary part of the equation...they will in effect cacel the need for their job moving forward...IMHO
You break it, you pay it.
And as they are also the root of the problem => They need to pay for it.
USDX technicals & stochastics are indicating near term $ weakness and plus silver finally breaking above $20 suggest QE2 may be coming to a screen near you.
More on the silver breakout:
http://silveraxis.com/todayinsilver/2010/09/13/silver-primed-for-volatil...
I have a geniune question and hope somebody smart here can answer it. Why is the market afraid of the inflation component?
With QE1 most of the money didn't trickle down, it was AFAIK used to monetize debt and shoulder up the BullShit aka "Balance Sheet" at the world's finest financial institutions. Wouldn't the same happen in case of QE2?
The markets prefer currency and buying power stability in it's 'price discovery' function. Adding uncertainty to the 'value' of the currency function just causes more volitility (upwards) to the price as the betters play at the casino.
Yes, but...
If the extra money isn't in free circulation in the market or among individuals, it shouldn't add to the decrease in purchasing power. Therefore it can only raise volatility on a purely psychological level for market participants. Is that what you mean?
Why is the market afraid of the inflation component?
The shtock market is scared primarily from rising oil prices and rising bond yields.
But since the Benzerker has embarked on his QE missions and wage inflation remains nonexistent we won't see rising bond yields due the Fed's balance sheet expansion program which will continue to expand exponentially approaching ~ as they buy/guarantee every type of loans iou's,securites known to mankind.This will finally end as they throw in the towel and accept those 5 dollars you owe to ya sister which by the way will ultimately cause the FED to self destruct.
Caron's problem is that he and his hedge fund clients are way out on the 'free money' limb busily sawing the limb off the tree.
He thinks he is channeling Bernanke and all he is channeling is his current bonus calc which says that his loser 'steepener' call earlier this year needs an 'all-in' bet now to make the max levels.
The issuance call is spot on (it happens every year) so Bernake's ability to command the yeild curve is at a premium. The thing that Caron misses is that we buyers are all crowded in on the short end of the curve and the issurers will take full advantage of that fact.
My guess is that it's POMO Lite for the duration of the year. Just another manifestation of 'extend and pretend.
Sad really but it's our version of Japan 1999. Absent an exogenous economic event ... this is going to be a dreary first quarter of the century from an investment POV.
Just sayin'.
I guess no change in the statement, with a nod toward "stabilizing" or "moderately improving" economic activity across Fed Regions. Bond market takes a header. Stock market takes off. Don't need QE to kill the dollar. Look at 2000-2008.
moved.
Could they trade together? No. MS would go through its risk limits before it took 10% of Goldmans position. Dont know why but MS are permabullish on everything. Even Basel is good for bank stocks RoE. (Duh, NO).
Not sure the last time I saw MS correct on anything. Close to the elections it's even tough for them to change their wording without it becoming political. So we keep seeing the same 'things are OK, slow improvement' etc for months. No QE until 2011 IMO, Bernanke doesnt want to do it.
ughhh banksters just suck
scum of the earth
ABOLISH THE FEDERAL RESERVE AND SAVE OUR COUNTRY!
Thank u, i found this for a long time.
cheap site hosting | windows web hosting | windows vps hosting | ucvhost