Recap 2014-10-09


The price moves in equities are bewildering. Massive moves, on no news. Even more interesting is that bonds barely moved today. High yield also sold off, but in a fairly modest fashion. In other words, it seems like equities are moving massively in a vacuum. People are de-risking by reducing equity leverage and going to cash only. That may sound like the market is full of goldbugs, but as we know, gold has gotten killed.

It has been popular to ascribe equity weakness to growth concerns, but bond yields do not support that hypothesis.

The only explanation I can think of is that someone is short a ton of gamma around the 1950 mark. There was similar volatility around that figure on 7/31 and mid August.

I’m grasping at straws though – I don’t really have anything other than price action to support that hypothesis. If true, another question is when the options mature. The October options expire next week, so there is a chance that this volatility around the 1950 figure goes away after next week. Open interest in SPX cash and futures options exhibit a strong tilt towards puts (and has been for some time) for strikes below 1960. Perhaps most of those puts are held by long only investors who are not actively delta hedging, which suggests dealer hedging has been a large driver.

The CBOE skew index has been elevated since late June, which suggests that market participants have been willing to pay a high premium for out of the money puts (relative to calls) since then, when SPX was trading around the 1970 level. The sharp drop on 7/31 corresponded with some normalization of that skew:

Not clear really – just another unverifiable hypothesis.

Another possibility is that with the end of QE looming, there is a sudden uncertainty regarding the appropriate clearing levels for markets.

I saw a few reports this afternoon noting that this price action was seen 3 days before the 1987 crash. How’s that for putting fear back into the markets? Note a major difference: back then, the Fed had started tightening about a year before. Reducing QE is not a tightening event, and also unlike then, bond yields are falling rather than rising.


  • BoE kept policy unchanged as exp
  • UK RICS House Price Balance declined to 30 vs 36 exp and 40 prev
  • German Current Account declined to 10.3Bn vs 13.8Bn exp and 21.7Bn prev
  • US Jobless Claims were stable at 287k vs 295k exp
  • Australia’s September employment change saw -29.7k lost jobs versus +30k expected. This was the largest decline since April 2011. If the Australian Bureau of Statistics not changed the method applied in September, the loss would have been 172k jobs. The unemployment rate declined to 6.1% from 6.2% since the participation rate declined to 64.5% from 65%. JPM: This is despite growth in the working age population of 1.8% annualized. A resumption of the weak trend in participation (not just on revisions), which is now back at the lows for the cycle, is therefore flattering the unemployment rate.


  • Fri: Canada Employment, USDA report
  • Mon: US Holiday, China Trade Balance, Australia Business Confidence
  • Tue: France CPI, UK CPI, German ZEW, US NFIB Survey,
  • Wed: Draghi Speaks, UK Employment, US Retail Sales, PPI, New Zealand PMI, Consumer Confidence, RBA FX Transactions
  • Thu: EU CPI, US Jobless Claims, US Philly Fed, NAHB Survey

8 thoughts on “Recap 2014-10-09

  1. >>Another possibility is that with the end of QE looming, there is a sudden uncertainty regarding the appropriate clearing levels for markets.>>

    Wielding Occam’s Razor, I favour this explanation. Faced with the end of QE and hikes in the somewhat foreseeable future, I don’t expect the market to entirely fall apart (there’s still a low rates underpin, after all), but I expect these periodic episodes of indigestive rumbling to continue to manifest themselves from time to time. It’s the New Normal (TM).

    I don’t think options positioning is the issue. After all, High Yield, EM, Small Caps etc have all had their sessions behind the woodshed without any adverse options positioning to drive price action. Unless the Fed calls the whole thing off, I expect these periodic tremors to continue to ripple through markets on a fairly regular basis. Which seems reasonable to me; the period of exceptionally low vol should by rights be drawing to a close.

    …rereading the above, it all seems terribly platitudinous, but as chess grandmaster Bent Larsen used to say: ‘long analysis, wrong analysis’ :-)

  2. We’ve had quite a bit of vol expansion in high yield and FX as well. Rates, not so much, but the fact that we haven’t seen as much vol in rates is probably because the market views the Fed on a roughly pre-set course. The emerging consensus seems to be that the Fed will raise a couple of times, then have to call the whole thing off when the edifice shows signs of creaking (some nod to that in the minutes yesterday). I have some sympathy for this view; we’ll have had 7 years of ZIRP, and the markets will have acclimated accordingly. I suspect 2% rates will feel to the markets like 5% rates felt back in the day. This scenario is obviously much more bullish risk asset vol than rates vol.

    1. That makes sense, but there’s still the idea that rates and equities are pricing in different things. Hard to argue that equities vol is higher because of fears of higher yields given rates market levels and vol, but maybe it really is just investors in different asset classes worrying about different things.

  3. You’re right; there’s a lot of cognitive dissonance about. One extreme case was on display last week when retail was dumping mReits pretty much contemporaneously with the underlying MBS assets making new highs, because, you know ‘rates going up’. In fact this ‘rates going up’ theme can be seen everywhere except the rates market!

    One way of attempting to reconcile this is to note that different markets have different ideas about what constitutes rates rising. For instance, last month, there was a lot of chatter about the 3yr crossing 1%, just to pick one example. Now to equity guys, this constitutes a selloff; to bond guys, it’s just the forwards being realised. In fact, with a steepish short end, bond guys can experience a rate rally (if the fwds aren’t realised), while equity guys can simultaneously experience a rate selloff (as spot rates are rising)! Bizarre, but there you go… Of course, this is only a partial part of the story, but listening to all this chatter about did lead me to somewhat reconsider my view that risk wouldn’t be able to sell off while rates stayed low, and that rates would have to rise unequivocally first before we could get a good game of Crack the Whip going.

    Another of my suspicions as relates to recent messy price action, is that we’ll only get to appreciate in the fullness of time how much the market ecosystem has been degraded over the last several years. HFT and regulation have seen off the traditional liquidity providers (the former seeing off the small guys, the latter the big guys), and this has implications all along the food chain. ZIRP and QE do a good job of filling in every bump in the road, which hides these underlying issues from sight, but I suspect when the market has to fend for itself a bit more, we’ll find out all isn’t healthy with the market microstructure. Maybe we’re seeing a little bit of that already?

    1. All very good points. Equity guys may be focusing more on the balance sheet, while rate guys in the path of Fed policy. While QE was ongoing, these were similar, but not any more…
      Given the misunderstandings around qe and macro in general that we know is out there, I guess I really shouldn’t be surprised by a sell off of this magnitude

  4. Appreciate the thoughts/analysis.
    Quick question – if your view is the 30y yield is on a downtrend currently helped by global growth concerns then wouldn’t the belly of the curve also rally as the pace of rate hike expectations adjust alongside? Or is the 5s30s flattener you highlighted in the post more for technical reasons? Thanks!

    1. Hi – the decline seems to be driven by both weakening cyclical concerns as well as slowing potential growth concerns. In that case, the long run real rate can fall even if the 5y pt is unchanged. Does that make sense?

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