Volatility

“Hedge funds have cost the states tens of billions in opportunity costs the last five years."

"Taxpayers and those who count on government services and investments will pay the price.”

"... a default cycle in commodity-related areas at this point is unavoidable, and the only real question here is whether it stays contained to those areas or extends itself to other sectors."

 The analogy is as if you notice an ember smoldering in a combustible forest you might be only somewhat cautious, perhaps even rationalizing it away.  But if you then notice a second ember smoking up...

Andy Hall's Astenbeck hedge-fund lost 9.7% in November, bringing 2015 losses to more than 26%. As a result of capital losses and mounting redemptions, Astenbeck’s assets under management fell to $2.4 billion, down from $3 billion at the start of the year and nearly $5 billion less than three years ago.

Government interference by both central banks and regulators (the latter are desperately fighting the “last crisis”, bolting the barn door long after the horse has escaped, thereby putting into place the preconditions for the next crisis) has created an ever more fragile situation in both the global economy and the financial markets. As the below charts and data show, price distortions and dislocations have been moving from one market segment to the next and they keep growing, which indicates to us that there is considerable danger that a really big dislocation will eventually happen.

Overnight market action has largely been a continuation of Tuesday's key themes with European stocks falling as a selloff in mining companies extended to a 7th day, even as metals prices rose and crude oil rallied modestly from a six-year low after yesterday's API crude inventory draw. U.S. equity futures have rebounded from modest declines, as emerging-market shares extended their losing streak to a 6th day while Asian stocks dropped to 2 month lows.

With just nine days until The Fed - which has prepared the world, apparently - will raise rates for the first time in years (and potentialy suck up to $800 billion of liquidity from the global collateral chains of shadow stability), it appears China is doing its best to start some destabilizing efforts (which worked last time). None of this is helped by the collapse in China trade (with imports down YoY for a record 13th month, and exports falling for 5 straight months).

"There are $1.1 trillion of S&P 500 options expiring on Friday morning. $670Bn of these are puts, of which $215Bn are struck relatively close below the market level, between 1900 and 2050. At the time of the Fed announcement, these put options will essentially look like a massive stop loss order under the market. This important event falls at a peculiar time—less than 48 hours before the largest option expiry in many years. "

Paul Volcker and Alan Greenspan were the Elvis and Beatles of this movement – the first to see widespread fame for their efforts. Then came Ben Bernanke, perhaps the Jimi Hendrix or Led Zeppelin of his day, taking existing tools and pushing them in new, previously unconsidered, directions.  Now, we have Janet Yellen and Mario Draghi, whose legacies are as yet undefined. They may end up like the next generation of rock stars from the 1970s – something like Bruce Springsteen, with a deep focus on common people in his music. Or, they could be the Bee Gees, who focused simply on commercial success. Only time will tell.

The US Federal Reserve (Fed) and European Central Bank (ECB) have created a very dangerous situation. And it is one that few if any investors are assessing.

"While funding continued to be available, such a large negative basis indicates potential market dislocations. And this may call into question how smoothly US dollar funding conditions will adjust in the event of an increase in US onshore interest rates. Similar pricing anomalies have also emerged in interest rate swap markets recently, raising related concerns."

"It is our humble belief that the consensus at the Fed does not fully understand the magnitude of the problems in corporate credit markets and the unintended consequences of their policy actions."

As we approach the Fed meeting expect markets to get more volatile. While the odds favor a move, it isn’t a sure thing until it is actually done. We found out last week what happens when forward guidance turns out to be forward misdirection. All those traders who thought they had a sure thing, who assumed that Draghi wouldn’t dare disappoint the market, got whipped. Whipped good.