Is Short Volatility Contained Or A Canary?

February 6, 2018

On Janet Yellen’s last day as Fed boss the markets suffered their worst percentage loss in 20-months.  Yesterday, on Jerome Powell’s first day as Fed Chairman, the VIX spiked by its largest amount on record and the Dow suffered its largest single day point drop ever (and 100th worst percentage drop in history).  Intent on showering us with some logic as prices rain lower, the media tells us that last week’s jobs report is responsible for the ongoing collapse.  But what the majority of the mainstream media and Wall Street (or the heads that talk their book in the mainstream) neglects to mention is that for the last 8+ years we have been living in a risk devoid wasteland of rigged prices, thanks in the large part to the Fed.

Suffice to say, the very idea that financial assets have climbed steadily higher since March 2009 because traditional inflation measures were contained (and now a spike in wages somehow presages inflation hell is afoot) is more than a little absurd.  To be sure, the markets have risen steadily since March 2009 because the Fed printed money and bought stuff.  To reiterate, by repeatedly printing money and buying stuff, the Fed’s experimental emergency policies helped produce the largest asset boom in history.

Reluctant at first, the rest of the central-bankalized world eventually followed the Fed’s lead and printed money to rig every major sovereign bond market (and, by extension, every major yield sensitive market).  These activities, done in unison and with permanent central bank swap-lines at the ready, induced carry trades, leverage, and a seemingly endless investor’ quest for yield (regardless of quality).   Knowingly or not, the financial world was operating under the proviso that risk doesn’t really exist when the money printers are in your corner – a platitude that made uncannily profitable sense until two trading sessions ago.

With the initial grenade having exploded, the conversation has quickly switched to where the shrapnel might land.  There are stories about short VIX bets gone terribly wrong, crypto-land is under intense fire (so much for Bitcoin replacing gold during times of trouble), and everyone has fixated a frightful eye on the bond market.  There is also the ripe speculation that after two days of financial market mayhem some yet to be disclosed participant(s) has been hurt in some yet to be disclosed ways.  In other words, as the opening bell sounds there is a fresh wafting of uncertainty in the air; a feeling that now unshackled volatility will not go back into its cave so easily or at least not for another Fed induced coma.

In short, the objective onlooker cannot help but concede that nothing irreversibly ugly has transpired to even remotely suggest that today’s price correction is about to morph into a financial calamity.  Rather, there is talk of VIX-related instruments failing, not of major firms imploding or corporations collapsing.  That said, as the central bank backed charade threatens to come to end it is not at all surprising that financial markets are throwing a little fit.

Volatility Index Spikes by Largest-Ever Amount  Bloomberg
The 116 percent increase is nearly double the next biggest one-day move for the gauge.

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Minting of gold in the U.S. stopped in 1933, during the Great Depression.