The Loudest Warning Yet: "This Stage Should Lead To Increased Risk... System Less Able To Deal With Such Episodes"

Tyler Durden's picture


Every quarter, as part of the Treasury's refunding announcement, the TBAC, aka the Treasury Borrowing Advisory Committee (aka the Supercommittee that Really Runs America), which is the committee that until recently was chaired by JPM and Goldman and which in 2014 handed over mock leadership roles to Dodge & Cox and BNY, shares some critical insight into what Wall Street's banks are really thinking in a private head to head with the US Treasury. As a reminder, it was this same TBAC which, several months after we warned about plunging asset liquidity, issued a warning about just this issue, something which even the Fed, whose QE is the primary culprit for the disappearance of high quality collateral, is now actively worried about.

So what did the TBAC hint at as one of the biggest concerns currently on the Treasury's mind? As it turns out, the primary charge (the secondary was even more interesting and we will discuss it in a post shortly) of the TBAC was to come up with its views on plunging, and until recently, record low market volatility, or as it also defines it: "Market Complacency And Excessive Risk Taking." To wit:

Asset price volatility has declined over the past two years both in the United States and globally. At the same time, forward-looking measures of market uncertainty across a range of fixed income, equity, and foreign exchange markets have also declined.


What are the Committee’s views on these developments and the factors that have contributed to the current environment of low volatility globally?

Remember, that it is not just the Treasury that is worried about plunging Vol. Ironically, so is the Fed (why it's ironic? read on).

Here is what the TBAC had to say on the topic of plunging volatility, market complacency and where we go from here (link):

Current State of Volatility

Monthly count of Bloomberg articles that contain the phrase “low volatility”.


Credit Suisse Interest Rate Volatility Estimate: yield curve weighted index of normalized implied volatility on a rolling series of constant at-the-money one-month expiry swaptions weighted across benchmark maturities 2yr, 5yr, 10yr and 30yr.

And for the irony: the bankers find, as we do, know that primary culprit for record low volatility is none other than the Fed itself with its vol-suppression policies (and Kevin Henry selling Vol futures). To wit:

Factors contributing to low volatility

  1. Actions by the Fed and ECB have significantly clipped the left tail risk, in terms of both economic outcomes and market outcomes (QE I)
  2. As interest rates approached the zero lower bound, rate vol is lower by construction which leads to maturity extensions, lower term premia and declining volatility across other asset classes through a lower and more certain discount rate (QE II)

* * *

But that's not all: here is what the all too clear punchline: "Suppression of yield and vol induces investors to take on more risk (QE III). The market clings to perception of certainty regarding outcomes, despite the Fed shifting commitment modes from time or level-based to data dependent. This stage of policy should eventually lead to increased uncertainty and risk."

Translation: the TBAC itself, whose summary assessment this is, is now actively derisiking!

* * *

For the VIX addicts and all those curious for more, here are some other key observations that substantiate the TBAC's view that now is the time to head for the exits.

Supply / demand factors in the options markets

Tail hedgers have decreased as evidenced by

  • Falling prices of downside puts on the S&P
  • Shrinking fund size of VIX ETF

Convexity hedging by mortgage accounts has gone down significantly after the crisis because of lower issuance and the Fed’s QE purchases. QE mortgage purchases remove both duration and convexity from the market, making it one of the most powerful policy tools.

QE mortgage purchases remove both duration and convexity from the market, making it one of the most powerful policy tools.


Market complacency and excessive risk taking

Interest rate volatility can be viewed as a proxy for the corporate bond market and the interest rate at which people and companies borrow money.

Shown below is 1y10y interest rate vol with 5yr spreads of the credit default index of investment grade on the left and high yield on the left

Note the lack of 10% corrections during the past hiking cycles in 2004 and 1994

Against environment of low vol and low returns, the only way to achieve the same return targets is to take on more risk

  • Ballooning AUM invested in hedge funds, now $2.7 trillion
  • VAR-based risk management frameworks and risk-parity investment models in which volatility is an input that determines the amount of risk to take


Mostly unchanged target for investment returns from the pension community. Latest data from November 2013 shows the median target shifted to just under 8% in 2012, despite the yield on Moody’s AA index having fallen to 4.2%.

Equity vol term structure has held up against complacency in the market place

FX vol term structure is also near the steepest level in the last 5 years.

Rate vol term structure is off the highs despite the Fed being closer to tightening than at any other point in the last 5 years


Equity volatility term structures


Interest rate volatility term structures


  • Monetary policy and regulatory changes have contributed to the decline in volatility.
  • Less demand for volatility across asset classes naturally lowers the price for such insurance.
  • VAR-based analysis leads to self-reinforcing loops as low volatility causes models to recommend scaling up risk.
  • The term structure of volatility is a powerful indicator; flatter vol curves would suggest excessive complacency and presage increasing risk.
  • Volatility tends to rise mid-to-late stage of the business cycle as expansive endeavors increase through the system.
  • An unexpected increase in volatility might come from broad-based selling of assets wanting to de-risk in front of a turn in policy.
  • With liquidity providers having declined in number and capacity, the system is less able to deal with such episodes of higher volatility. Institutions which deliver absolute returns or provide liquidity to the system would be most at risk.

* * *

It couldn't be said any clearer.

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Wed, 08/06/2014 - 11:33 | 5054156 q99x2
q99x2's picture

Bankster propaganda. You just BTFD and don't worry about it.

Wed, 08/06/2014 - 12:02 | 5054322 dontgoforit
dontgoforit's picture

That's a lot of graph.

Wed, 08/06/2014 - 12:11 | 5054358 barre-de-rire
barre-de-rire's picture

that's a lot of bullshit

Wed, 08/06/2014 - 12:36 | 5054507 max2205
max2205's picture

Chart City!

There's a bonus chart in there somewhere !

Wed, 08/06/2014 - 13:18 | 5054708 SoilMyselfRotten
SoilMyselfRotten's picture


Wed, 08/06/2014 - 12:15 | 5054381 Save_America1st
Save_America1st's picture

Chart Porn-O-Rama!!!!

Just keep stackin' phyzz..."Folks" ;-)

Wed, 08/06/2014 - 11:35 | 5054174 PartysOver
PartysOver's picture

Wow ready that was more fun than watching porn.   To the SEC, now I get it.

Wed, 08/06/2014 - 11:37 | 5054187 Catullus
Catullus's picture

Wow. Right-wing but jobs in the treasury now?! How dare they doubt the Recovery!

Crack-up boom indeed.

Collar time

Wed, 08/06/2014 - 11:41 | 5054202 LawsofPhysics
LawsofPhysics's picture

Come on, we all know that since 2008/2009 all "risk" will be covered by taxpayer-funded BAILOUTS.

(of course, all the "rewards" will be kept by the CEOs and those "in the club")

Wed, 08/06/2014 - 11:42 | 5054208 ATM
ATM's picture

“The SEC voted on July 23, 2014, to require a floating NAV for prime institutional money market funds and provide non-government money market fund boards with new tools — liquidity fees and redemption gates — to address runs.”

Wed, 08/06/2014 - 11:59 | 5054309 Dr. Engali
Dr. Engali's picture

I usually address runs with a dose of Imodium-Ad. 

Wed, 08/06/2014 - 12:21 | 5054420 IndyPat
IndyPat's picture

A 20 lb. block of Government cheese should bind you up for a month or so.

Wed, 08/06/2014 - 11:43 | 5054215 IndyPat
IndyPat's picture

Liquid risks.


Which contagion are we talking about?

Wed, 08/06/2014 - 11:46 | 5054230 Winston Churchill
Winston Churchill's picture

Qebola of course.

Wed, 08/06/2014 - 11:53 | 5054267 IndyPat
IndyPat's picture address runs...

Bank runs and bloody loose bowels. This is so awesome.

Wed, 08/06/2014 - 12:16 | 5054396 Save_America1st
Save_America1st's picture

QE-bola...that's a classic! 

Cured with stacks of pure .9999 fine Ag and 30ppm coloidal silver solution ;-)

Wed, 08/06/2014 - 11:45 | 5054223 thatthingcanfly
thatthingcanfly's picture

I have no idea what I just read.

Wed, 08/06/2014 - 11:48 | 5054239 IndyPat
IndyPat's picture

I get the feeling it's intended that way.

Wed, 08/06/2014 - 12:17 | 5054399 Da Yooper
Da Yooper's picture

The writer was a graduate of the Alan Greenspan school of bull shitting

Wed, 08/06/2014 - 12:32 | 5054489 Winston Churchill
Winston Churchill's picture

Did he dribble all over the text ?

Wed, 08/06/2014 - 11:49 | 5054243 Oldwood
Oldwood's picture

Self-reinforcing loops of optimism driving a false sense of prosperity, while ignoring all reality. Everything is fine.

Wed, 08/06/2014 - 12:04 | 5054330 dontgoforit
dontgoforit's picture

Well said, oldwood!

Wed, 08/06/2014 - 12:07 | 5054349 Nacho.Libre
Nacho.Libre's picture

Everything is better than fine, everything is AWESOME!

Wed, 08/06/2014 - 12:56 | 5054598 Iriestx
Iriestx's picture

Reality takes a back seat to taxpayer funded bailouts and the printing press.

Wed, 08/06/2014 - 11:53 | 5054272 Dr. Engali
Dr. Engali's picture

In a nutshell, the fed suppressing volatility and distorting markets is creating a passive 'investor' who is not afraid of risk, and when the selling starts there won't be anybody there to buy.

Wed, 08/06/2014 - 12:01 | 5054320 L3G4CY
L3G4CY's picture

The FED should be there to buy!!

Wed, 08/06/2014 - 12:11 | 5054369 Chupacabra-322
Chupacabra-322's picture

QE to infinity

Wed, 08/06/2014 - 12:12 | 5054368 IANAE
IANAE's picture

What they said... self reinforcing cycle of optimism without any safety or reality checks...

Think of a naive excel model where a growth process compounds ad infinitum and the modeler thinks they are going to be rich.

Now think of different growth process that compounds, and metastasizes, until the host ceases to exist.

Which process do you think this is?

Wed, 08/06/2014 - 12:11 | 5054370 Uchtdorf
Uchtdorf's picture

It says:

I know that you believe you understand what you think I said, but I'm not sure you realize that what you heard is not what I meant.

Wow, that line really dates me.

Wed, 08/06/2014 - 11:46 | 5054227 williambanzai7
williambanzai7's picture

Risk is stuffed and on display in the Smithsonian

Wed, 08/06/2014 - 11:54 | 5054275 Eyeroller
Eyeroller's picture

... alongside all the other extinct species.

Wed, 08/06/2014 - 12:25 | 5054443 teslaberry
teslaberry's picture


financial contagion may start spreading bonzai. what is putin going to do about this? and do the chicken fuckers have anything to contribute regarding the kind of work necessary to profit from QE-bola?

Wed, 08/06/2014 - 11:46 | 5054231 Oldwood
Oldwood's picture

All Obama needs to do is "promise" that ALL losses will be nationalized. Then its off to the moon! We will all be winners then!

Wed, 08/06/2014 - 12:58 | 5054604 Iriestx
Iriestx's picture

Socalize losses and privatize profits!  HOPE and CHANGE!

Wed, 08/06/2014 - 11:48 | 5054237 besnook
besnook's picture

when the crowd goes one way go the other way. time honored investing advice.


this is the most predicted correction in the history of the market. it is a setup. btfd

Wed, 08/06/2014 - 13:00 | 5054615 Iriestx
Iriestx's picture

This maxim doesn't even remotely hold true any more.  Endless printing and bailouts makes it irrelevant.  The stock market will never, ever go down over the long term, until it goes to zero, and it's going to take a catostraphy of biblical proportions to make that happen.

Wed, 08/06/2014 - 11:51 | 5054252 Dr. Engali
Dr. Engali's picture

Don't worry, when the time comes the HFT robots will provide plenty of liquidity to help absorb the downside.....

Wed, 08/06/2014 - 11:52 | 5054268 buzzsaw99
buzzsaw99's picture

round up the usual suspects

Wed, 08/06/2014 - 11:55 | 5054285 Eyeroller
Eyeroller's picture

how do you round up an algo?

Wed, 08/06/2014 - 12:40 | 5054528 WillyGroper
WillyGroper's picture

plug a simplex fiber into both the input & output.

Wed, 08/06/2014 - 11:55 | 5054286 IndyPat
IndyPat's picture


Ben is napping.

Wed, 08/06/2014 - 22:41 | 5057203 IANAE
IANAE's picture

...from the barbershop quartet in Skokie?

Wed, 08/06/2014 - 11:56 | 5054291 TrumpXVI
TrumpXVI's picture

That's a lot of charts...too many charts.

Couldn't Goldman just sum it all up in a swirlogram for me?

Wed, 08/06/2014 - 13:12 | 5054679 Pareto
Pareto's picture

+1.  Those swirlograms are fucking retarded.

Wed, 08/06/2014 - 15:07 | 5055276 Frank N. Beans
Frank N. Beans's picture

In the southern hemisphere, they swirl in the opposite direction.

Wed, 08/06/2014 - 12:02 | 5054316 Mercury
Mercury's picture

 The market clings to perception of certainty regarding outcomes, despite the Fed shifting commitment modes from time or level-based to data dependent.

Not to mention shifting the goal posts.  No one is even pretending anymore that the Fed is going to actually sell the securities on it's balance sheet back to the market right?

Wed, 08/06/2014 - 12:05 | 5054339 ghostzapper
ghostzapper's picture

Nothing to see here, move along now.  Still tracking for that bounce from 1890-1905 and then yet another BTFWTFer rocket ship to 2100ish and THEN the crash . . . . . . . but nothing to worry about when the tutes dump what they didn't dump on the way up of the last wave I'm sure the geniuses at Fast Money can absorb all of that stawk supply, right?

Wed, 08/06/2014 - 12:09 | 5054355 Chupacabra-322
Chupacabra-322's picture

Ah yes,

I can hear the voices of PsyOp / Propaganda / Criminal CIA writing the False Narratives now.

Wed, 08/06/2014 - 12:09 | 5054356 disabledvet
disabledvet's picture

Berspanke crushed the bubble last year with Ye Olde Volte Face vis a vis taper. The shorts were having a good time of it until gold got annihilated, stocks moon shot and the dollar thrashed pretty much the entire planet.

Since that time Putin has invaded, the euro zone (economically speaking) has collapsed and Ebola is now on the move.

Gold won't do ya any good if you've got an Outbreak.

Wed, 08/06/2014 - 12:22 | 5054421 mastersnark
mastersnark's picture

I only use pie charts. These mean nothing to me.

Do NOT follow this link or you will be banned from the site!