Markets are fairly quiet, with much of Asia shutting off for the Lunar New Year...
But, as former fund manager and FX trader Richard Breslow notes, it hasn't been as quiet a day as things look. Nevertheless, we’re back in selling volatility mode, as even known risks are getting little attention from options traders. There’s plenty of talk about all of the financial risks out there, and the deferred maintenance by policy makers in dealing with problems. And then going out to look for some carry to load up on. It looks nice on the screens, but it’s very unhealthy.
There’s renewed interest in the systemic threat from the mountain of sovereign debt that has been issued by Italian governments over many years. The fact that so much of it is held by domestic and other European banks puts them directly at risk from any credit crisis. Not an entirely far-fetched possibility. How investors are addressing this danger is an object lesson for how global investing decisions are being made in general.
The Italian economy is in “technical” recession. Which is a nice way of saying there is a recession going on but we need to sugarcoat what we call it. Bank of Italy Governor Ignazio Visco acknowledged this weekend what other European forecasters have been saying. Growth is likely to sorely disappoint. The official 0.6% growth forecast for this year is “subject to downside risks.” He warned of the risks from higher borrowing costs.
Unsurprisingly BTPs opened softer even after Friday’s global back up in yields. And then, you got it, buyers emerged in the cash market as traders couldn’t resist yields they hadn’t been offered in two weeks. And they have been grabbing them up in amounts that saw volumes running well above average.
Central banks are going dovish as the global economy slows and everything is therefore right with the world. The ECB is widely expected to push rate-hike expectations off until next year. Even that sounds optimistic. And no one would be surprised at a new round of TLTROs. The BOJ isn’t backing off its stimulus. The PBOC is being counted on to keep trying new measures to stimulate growth, even at the expense of their deleveraging efforts. And the Minneapolis Fed’s Neel Kashkari appears to be taking a victory lap, with Fed Chairman Jerome Powell “coming around” to his wait-and-see approach.
If carry and yield are kings again, is it any wonder that implied volatility in currencies continues to sag? The recently reborn practice of hedging for geopolitical risks has suffered from crib death. “Global headwinds,” the favorite throwaway line in all central bank communiques, is once again taken as signal to go out there and buy.
It’s a big leap of faith to expect that this will all work out as it did before. But that’s what we’re being asked to do. And in response, markets have taken asset prices to levels where investors will have to decide in which basket to place their eggs.
Some pivot levels to watch include how the Russell 2000 behaves from right here at 1500 up to 1550. Whether the MSCI emerging market index falls back from, or surmounts the 1660 level it was unable to best at the end of last week. Similarly, the dollar index is trying to bounce from last week’s low and conveniently, the 200-day moving average is at a point that is an even closer proxy for near-term sentiment. The current level of 2.70% in the 10-year Treasury is a good place to determine how this week may play out.
Perhaps the most interesting, if a little more obscure, is to watch if last week’s technical breakdown below 70 basis points of investment grade CDX has legs or was the blow-off to fade.
They have led us to the water and now we will see how deeply investors choose to drink.