Thursday, June 30, 2016

Move Along Folks – No Black Swan Here

Earlier this month following Fed Chair Yellen’s remarks at the June 6th World Affairs Council appearance, I made note of the extraordinary attention she gave to the level of uncertainty outstanding and its implications for predicting economic outcome and therefore monetary policy application (See; ‘Yellen – Never so Much Emphasis on Uncertainty’).  Her comments were quickly reduced by many to the ‘least denominator’ of policy rate implications and of course that meant expectations for policy rate firming were removed. 

Of course the Fed followed with a tempered view in the June FOMC statement and Summary of Economic Projections where expectations for policy rates were reduced substantially.  Because much this newer Fed-leaning had been inferred by Yellen’s comments along with other officials, like the apparent ‘flip’ from hawkish to dovish by St Louis Fed President Bullard, economic agents had by the FOMC meeting date already priced reduced policy rate expectations. 

Skip forward to the UK vote to leave the Euro.  Here additional uncertainty was heaped upon market participants.  It may not be unfair however to argue that some level of unearned confidence was assumed as regards a ‘Stay’ vote outcome.  Reliance on betting houses which seemed to score the odds in strong favor of a stay vote could have prompted some who would have otherwise hedged an ‘adverse’ outcome from taking those steps.  As such, there may have been a greater immediate reaction to the ‘leave’ vote than there otherwise might have been.  General sentiment that economic conditions at large were uncertain also would have contributed to volatility, allowing for greater swings in asset prices.

Since the UK vote, many more officials throughout the UK and Europe in particular and elsewhere more generally, have spoken of highlighted levels of uncertainty.  At this stage, one has to wonder if this uncertainty is not overstated, that conditions are not so beyond expectation or comprehension that trends cannot be discerned and economic output modeled along with likely asset price and monetary policy responses. 

Looking to market reaction over the last couple of sessions, only days following the ‘historic’ UK vote, a sense that credit concerns are becoming more focused rather than general gives rise to expectation that additional repair of distressed asset price reaction from the leave vote is still before us.  We might remember further that the UK leave vote was not a ‘black swan’ event.  A black swan (Taleb) refers to the event that happens which was totally unseen in coming. 

Importantly, the UK vote was a knowable event.  We readied for it and some of us stayed the night watching it unfold.  The vote of course did not go the way of the betting books.  Markets reacted strongly as the results came in.  Some might argue markets overreacted.  However, over reliance on betting book results could have swayed otherwise conservative parties not to have hedged the event. 

In any case, professions of heightened uncertainty have reached climactic proportions even as asset classes have started to repair.  Note the VIX which had vaulted nearly 9 points overnight on the 24th from 17.25 to 26.24.  Interestingly, my candlestick analysis has that session as a ‘bearish hanging man’ which warns of a reverse lower.  The next session in candlesticks formed a ‘bearish shooting star’, again warning of lower volatility levels.  The lower volatility implications of those price formations were confirmed by further weak price action over the coming sessions and now the VIX has returned and is below levels existing in front of both the UK vote and the June FOMC meeting.  Additionally, the Merrill Lynch ‘MOVE’ Index (Treasury Volatility), having jumped higher following Yellen’s June 6th speech and remaining higher through the UK vote has softened over the last days and is now below the 50 and 100 day moving average. 

The implication for the above is that financial markets have reacted strongly to both an unexpected UK vote and pronouncements by numerous officials that ‘uncertainty’ reigns.  While markets will continue to react to forthcoming data, visibility has not completely disappeared and active managers are returning to take advantage of mis-priced assets.  Assumptions that ‘risk-off’ will prevail for an extended period has not been born out in asset price action over the last 48 hours.  Price action over the last week is more consistent with a mis-read of event unfolding as a ‘black swan’ which it is not.     

Very generally speaking, we might expect that equity prices will continue to repair higher, gold prices will be relieved of some of this month’s gains and that U.S. fixed income, though buoyed by lower European rates will find modest selling pressure from continued moderate economic growth.  





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