Earlier today, RBC’s Charlie McElligott explained why today’s action is indicative of one or more energy/risk-neutral/value funds blowing up. Now he looks at the underlying cause, and attributes it to the inability of investors to discriminate between real and imaginary threats in what has now become a “deafening cacophony of noise.”
THE DOLLAR MELTDOWN
We are currently in the midst of a sixth-consecutive day of declines for the USD. The past week’s acceleration of legacy ‘long Dollar’ liquidations (as new EUR longs are built as well) sees absolute trade-weighted indices (BBDXY, DXY) AND net USD spec positioning back at pre-election levels. This move in Dollar is primarily occurring on two fronts:
- The tightening of US / EU rates differentials, as US data has softened simultaneously into the ECB accelerating their ‘less dovish’ / tapering rhetoric. As such, we see EUR making highs since pre-election.
- The ever-mounting storm clouds over the Trump administration, with the increasingly ‘unhinged’ President now under-fire via the Comey ‘memo’ communicating pressure from DJT with regards to the FBI’s Mike Flynn investigation, telling the then-Director “I hope you can let this go” (we are now hearing calls for “impeachment” growing louder, although legally by those comments alone, it is highly debatable as to whether this is ‘tampering’ / ‘obstruction’).
US / EU rates differentials dictating Dollar direction, and mirrors the decline in net spec longs
VOL AND ‘WHITE NOISE’:
The largest implications of the Dollar-move from an FX perspective are with Euro shorts (a greater than 2SD % move higher over the past four sessions) and Yen shorts ($/Y -150pips from yesterday’s highs), although the broad FX market volatility remains in the same ‘zombie-state’ as other asset classes, with CVIX just +3.9% WTD.
This brings up another point: ‘short vol’ has been a ‘loaded’ and profitable factor across all major asset classes for years now…not just equities. And from a 30k foot view–outside of the performance derived from ‘short vol,’ central bank rate suppression / intervention and the growth of ‘negative convexity’ strategies—it increasingly feels like this broad and painfully constant “uncertainty” meme is a large part of the ‘low volatility problem’ in-and-of-itself. The “rolling crisis” world we’ve operated in since ’07 has only gotten worse with armchair quarterbacking from the 24/7 news media now being escalated exponentially via social media.
The punchline: the cacophony of noise is deafening, so much so that investors have become utterly desensitized to what constitutes an actual threat to their portfolios versus what is just ‘static.’ The path-of-least-resistance implication? Tune it out and stay ‘long-and-strong’ under the guise of ‘slow but realizing economic recovery’ and central bank ‘puts.’ The rest is simply “paying-away performance” via hedging that saps alpha, which in light of a world of negligible yield, is not a viable option.
So you either profit from it (sell vol and collect premium) or you go unhedged. Caveat emptor.
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Here is another way of visualizing this: the correlation between “crisis” stories and VIX has recently gone negative.
