Former Bundesbank Head Explains The Lull Before The VIX Storm

Tyler Durden's picture


Authored by Axel Weber (UBS Chairman and former Bundesbank President), originally posted at The FT,

When the governing council of the European Central Bank meets in Frankfurt on Thursday, it is widely expected to announce a loosening in policy – most likely a cut in both the refinancing and deposit rates. Two weeks later, the US Federal Reserve will probably respond to strengthening economic data by moving in the opposite direction, tapering the pace of quantitative easing for the fifth consecutive meeting. This is another sign of how monetary policy is diverging in the two largest economies, a trend that is set to shape funding markets for years to come.

In the US, output is set to rebound in the second quarter after having been disrupted by dismal weather in the first. And while price rises have been subdued so far, employment surveys suggest an emerging skills shortage and thus the potential for wage cost growth that could help lift inflation close to the Fed’s 2 per cent target. By any measure the labour market is tighter in America than in Europe, where the recovery remains weak and uneven despite buoyant financial markets. The gap between actual and potential output will barely shrink in the eurozone this year, and unemployment will remain close to a record high.

Before long, these divergent fortunes are bound to lead to large differences in policy. In the US, interest rates could begin to rise in 2015. In Europe, they are likely to stay low for much longer.

One might expect that movements in financial markets would reflect these expectations. However, so far, by and large, they have not. The dollar has been ailing for months, defying analysts’ expectations that the currency would strengthen in anticipation of higher US interest rates. What is going on?

The answer is that market expectations seem to count less than current conditions, which still support the euro. First, the high yields on government debt in countries such as Italy and Spain have made them an attractive investment for believers in the ECB’s pledge to do “whatever it takes” to save the euro. Second, America’s shrinking pension deficits may have stoked appetite among pension-fund managers to lock in profits and match liabilities, helping suppress long-term bond yields. And then there are the central banks. The Eurosystem’s balance sheet has been shrinking for more than a year, as banks that borrowed from the central bank under the longer-term refinancing operation (LTRO) have repaid their debts early. Meanwhile, the Fed’s balance sheet is still growing, albeit at a reduced rate.

However, these factors are temporary. LTRO repayments are coming to an end, US quantitative easing will be completed by the end of the year, five-year government bond yields in Spain are already similar to those in America and long-dated US government bond yields are pricing in unrealistically low expectations of future economic growth. Diverging monetary policy will soon begin to have more impact.

To my mind, investors should prepare for more volatility this year. The degree of easing of US monetary policy has been exceptional. The tightening, when it begins, will also be unprecedented. The tightening has not yet begun – the Fed’s balance sheet is still expanding. I see significant potential for volatility and setbacks on financial markets over the next few quarters.

In particular, the story is not over for emerging-market countries that rely on cheap dollar funding. The recovery of their stock markets and currencies in the past months does not reflect improved economic fundamentals, but a better mood among investors. These countries are still vulnerable. When US interest rates begin to rise, these borrowers may be able to turn to euro-denominated debt as an alternative source of cheap financing. However, this at best delays adjustment; improving fundamentals remains urgent.

The Fed’s balance sheet, which was about half the size of the Eurosystem’s going into the crisis, has now overtaken its European counterpart as a proportion of output. Emerging markets will not be the only ones to suffer when this trend goes into reverse. A tightening in US monetary policy always causes fallout. This time will be no different. In fact, it may be worse, since the tightening starts from extremely expansionary territory.

As we noted previously, it's just a matter of time...



h/t @Not_Jim_Cramer

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Tue, 06/03/2014 - 09:51 | 4819875 HedgeAccordingly
HedgeAccordingly's picture

europeans are funny... – Deutsche Bank Co-CEO Anshu Jain: ‘Europe is stable now…the ECB has done a lot to createstability”

Tue, 06/03/2014 - 10:07 | 4819908 NoDebt
NoDebt's picture

I love reading articles where the author gets the directionals roughly right, but his assessments on where things stand currenly is dropped in from the moon.  

"Europe's recover is slow and uneven compared to the US"  Which means ours must be robust??

Boom!  My head just exploded.

Tue, 06/03/2014 - 11:42 | 4820206 Four chan
Four chan's picture

the banks are hot house flowers under zirp and the fed buying all their bad paper. the banks are sitting back and buying stocks and everything else and are uninterested in re-raping we the people with debt. when the fed stops, if they can, the banks will get back into the lending game in a big way soaring interest rates, a falling stock market, and raging inflation will ensue. since we are toppy sitting back and waiting for the ball to come to you sounds like the prudent course to take for all of us future victims of the central bank.

end the fed.

Tue, 06/03/2014 - 09:53 | 4819881 SaulRosenberg
SaulRosenberg's picture

I would like to remind all that the vix can remain low (artificially or not) for a VEEEERRRRY long time...years do yer homework and keep yer eyes open to all opinions.

Tue, 06/03/2014 - 11:28 | 4820164 813kml
813kml's picture

The question is, will the TPTB blame the VIX Storm on global warming?

Tue, 06/03/2014 - 09:56 | 4819884 AccreditedEYE
AccreditedEYE's picture

Keep giving us those long-term VIX charts... In an age when fundamentals don't mean crap neither do the charts.

Tue, 06/03/2014 - 10:22 | 4819939 Hippocratic Oaf
Hippocratic Oaf's picture

Can I use that?

Quote of the day so far.

Tue, 06/03/2014 - 10:26 | 4819953 schatzi
schatzi's picture

Keep giving us those long-term VIX charts... In an age when fundamentals don't mean crap neither do the charts.


The VIX has little to do with fundamentals -> i.e.  fundamental macro-economic data. VIX is an expression of expected stock market volatility (by market participants).

In an age where funadamentals mean fuck-all, other indices such as VIX might actually be more applicable to judge future market movements.

Tue, 06/03/2014 - 10:40 | 4819997 AccreditedEYE
AccreditedEYE's picture

Without going into an overly long explanation, I'll simply say that I disagree.

Tue, 06/03/2014 - 11:29 | 4820170 schatzi
schatzi's picture

Which is a pity as I'm always keen on interesting discussions.


BTW, I disagree on the author's overly optimistic forecasts on US economic recovery and thereby forcing the Fed hand to increase rates and accelerate tapering. The graph is an accurate warning though. Complacency means lacking anticipation. Low VIX means lacking anticipation. Should the Fed be able to ecape that corner it painted itself into, it creates a real risk of repeating history. Stock market crashes by their very definition are not anticipated by the market majority.


In any case my original point centres around the idea that the Fed has created a liquidity glut that makes fundamentals irrelevant and creates a stagnant price plateau that only panicked market participants can disturb. Observing market participant expectations is therefore quite relevant in my opinion.

Tue, 06/03/2014 - 10:03 | 4819891 JustObserving
JustObserving's picture

Applying rational analysis to manipulated markets is like bringing sand to the Sahara.  Facts matter not a bit when the Fed can manipulate every market for decades.

Don't short the stock markets or US treasuries if you value your wealth or sanity.

Tue, 06/03/2014 - 10:51 | 4820045 Panafrican Funk...
Panafrican Funktron Robot's picture

Yeah, I read this as "UBS needs more muppets to slay", specifically, muppets that buy volatility.

Tue, 06/03/2014 - 10:05 | 4819895 Fuh Querada
Fuh Querada's picture

A dense collection of half-truths, myths, subjunctives and suppositions predicated upon the expectation of truthful statements by central banks and agencies that provide economic "statistics"

"tapering the pace of quantitative easing for the fifth consecutive meeting...."

"In the US, output is set to rebound in the second quarter"

"And while price rises have been subdued so far,"...

"potential for wage cost growth"

Yeah Right.

Tue, 06/03/2014 - 10:06 | 4819906 OceanX
OceanX's picture

You can sum it up in two syllables, nonsense...

Tue, 06/03/2014 - 10:06 | 4819907 OceanX
OceanX's picture

You can sum it up in two syllables, nonsense...

Tue, 06/03/2014 - 10:29 | 4819955 Colonel Klink
Colonel Klink's picture

So good it beared repeating.

Tue, 06/03/2014 - 10:02 | 4819898 FranSix
FranSix's picture

Instead of trading VXX, you may want to consider spread trades in gold futures contracts between near futures and DEC 2019.

Tue, 06/03/2014 - 10:07 | 4819900 Dr. Engali
Dr. Engali's picture

 "By any measure the labour market is tighter in America than in Europe, where the recovery remains weak and uneven despite buoyant financial markets. "



What in the world are these people smoking? The labor markets are tight int the U.S? Tell that to the 47 million people on SNAP. And the millions on unemployment. As for the rate hike in 2015 I'll remind them of this little ditty:



"No rate normalization in my lifetime"


~The Bernank



Tue, 06/03/2014 - 10:09 | 4819911 NoDebt
NoDebt's picture

Same phrase I couldn't get past, either.

Tue, 06/03/2014 - 10:15 | 4819921 Dr. Engali
Dr. Engali's picture

I don't understand why anybody believes we will avoid the same outcome as Japan. We are following the exact same policies on a much larger scale.

Tue, 06/03/2014 - 10:32 | 4819965 JRobby
JRobby's picture

As our population ages day by day.

Japan has a slightly older demographic.

Tue, 06/03/2014 - 11:01 | 4820082 Panafrican Funk...
Panafrican Funktron Robot's picture

This.  The most likely path for the USD is that it becomes another "yen carry" type of vehicle to buy mostly Asian financial vehicles.  Suppressed yields/volatility/headline inflation, low nominal growth / negative real growth, "zombie" banks continue on, though they're really more of a zombie vampire.

Tue, 06/03/2014 - 17:06 | 4821257 Bazza McKenzie
Bazza McKenzie's picture

Except Japan is not spending trillions of dollars it doesn't have "policing the planet" and it has a homogeneous population relatively willing to accept privation "for the good of the country".

Japan looks better able to cope with economic Japanisation than does the US.

Tue, 06/03/2014 - 10:15 | 4819919 JRobby
JRobby's picture

Like comparing the shit of two terminal patients.


"This one looks a little better than that one. Oh, the insurance just ran out for both, dump them in the alley. hospice is all full"

Tue, 06/03/2014 - 10:20 | 4819934 Stuck on Zero
Stuck on Zero's picture

Definition of "tight labor market" from CEOs and Elitists Dictionary: "Fewer than 20,000 applicants for a minimum wage job at WalMart."


Tue, 06/03/2014 - 10:04 | 4819902 disabledvet
disabledvet's picture

Bwhahahahaha. "No bubble here!"

Tue, 06/03/2014 - 10:04 | 4819903 Australian Economist
Australian Economist's picture

My S&P 20000 hat is in the post, I hope it arrives in time.

Tue, 06/03/2014 - 10:06 | 4819905 MFL8240
MFL8240's picture

A tightening in US monetary policy always causes fallout. 


Better chance that the Easter Bunny will come!

Tue, 06/03/2014 - 10:15 | 4819920 TheRideNeverEnds
TheRideNeverEnds's picture

Its over; the VIX is finished.

Tue, 06/03/2014 - 11:03 | 4820087 Crispy
Crispy's picture

I assure you it is not different this time...

Tue, 06/03/2014 - 10:20 | 4819928 buzzsaw99
buzzsaw99's picture

sure, whatever :eye roll emoticon:

Tue, 06/03/2014 - 10:23 | 4819941 Son of Loki
Son of Loki's picture

"Stagflationary Shit Storm," is what my broker calls what's ahead.

I asked, but he did not know, whether "Shit Storm" is one or two words.

Tue, 06/03/2014 - 10:29 | 4819957 Everybodys All ...
Everybodys All American's picture

I know summer markets are generally slow but this market is grinding to a halt as it looks like nearly no one is actually trading. Thanks Bernanke and now Yellen you have screwed an entire generation of savers on top of it for this outcome.

Tue, 06/03/2014 - 10:41 | 4820006 intric8
intric8's picture

wouldnt be surprised if the spoos creeps up and vix creeps down all the way till next election, bearish economic news notwithstanding. Watch fedres keep pounding that square peg of fabricated financial absurdity into the round hole of reason while the clueless sheeple proclaim 'wow, that dude with the sledge hammer looks pretty buffed.. maybe hes a model or something'

Tue, 06/03/2014 - 11:42 | 4820208 GoldenDonuts
GoldenDonuts's picture

This guy seems to be under the impression that these two central banks work independtly.  No they are taking turns devaluing and in turn making sure that the spice flows to the chosen ones.

Tue, 06/03/2014 - 11:51 | 4820236 smacker
smacker's picture

"In the US, output is set to rebound in the second quarter after having been disrupted by dismal weather in the first."

Arrgghh. So the 1st quarter's poor performance was the weather after all.

Relax guys, the economy's on the brink of a new super-boom. ;-)

Tue, 06/03/2014 - 12:07 | 4820292 orangegeek
orangegeek's picture

"...In the US, output is set to rebound in the second quarter after having been disrupted by dismal weather in the first...."


Fucking liar!!!!!!!!!!!!!!!

Tue, 06/03/2014 - 13:13 | 4820557 Herdee
Herdee's picture

It's not a question of time if you've become another Japan.How about a lost decade.America is no different.You're broke.Interest rates can never rise because there's no tax base to support the 17.5 trillion deficit.If you raise interest rates you'll kill the job market for good and make it more expensive for small and medium sized business.That means massive layoffs.If you want to extend the current depression it's a good thing to do,raise interest rates.So.where's the Government going to get its' money from in order to support the right wing neo-cons in the State Department?It seems that they're in charge and have taken over policy in order to find ways to destroy the U.S. monetary system.You must lead the neo-con controlled Puppet says.So, now it will be another wasted trillion dollars or two moving U.S. toops into eastern Europe for another pretend cold war which will mean absolutely nothing to Russia except to see the U.S. continue to up their debts.Anything to bankrupt America.Just continue on the current path of neo-conizm.

Tue, 06/03/2014 - 15:49 | 4821058 MeelionDollerBogus
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