VIX index points to major risk event
Chief Investment Officer
Summary: This is getting serious. Very, very serious: the VIX fear gauge is flagging a huge risk event on Friday – the China-US trade deal cliffhanger. Our Saxo Strats view the outlook as binary: 5% to 10% to the upside should a diplomatic thaw occur, but perhaps a 25% plus correction if the talks end in acrimony.
COMMENT: This is a “separate” and “standalone” exercise vis-à-vis a breakdown in trade talks between the US and China as liquidity, or rather, illiquidity, is behind all major market selloffs in history and this weekend has the biggest short position in volatility ever!
Saxo Strats view: This is now a binary outlook –
1. Either we get a diplomatic “softening” and a 5-10% upside
2. or this could accelerate into a > 25% correction
OVERALL this matches our “False Stabilisation” macro theme, where we argue the transitory impact from the lower price of money is just that, a "blip” in the downtrend in economic activity and credit facilitation which we expect to bottom by August……
• We still see 75% chance of “some diplomatic agreement”, but the 25% tail-risk is now in play due to the “illiquidity constraints” illustrated below.
This first chart is from Marko Kolanovic @ JPMorgan and shows the relationship between VIX vol and liquidity. The relationship declines exponentially with the rise in VIX.
We have exceeded 22.50% in VOL just ahead of the New York open today…
The red arrows (done by me) show how we have moved from a rich liquidity of 6-8 K contracts to less than 2K……..as VIX rises, so does illiquidity.
The end risk here is – and its always the case in market crisis – that the market runs out of liquidity in this case in derivatives, not something the Federal Reserve can directly impact. (In this respect it mirrors the 2008/09 crisis where CDO, SPV became illiquid and created massive losses).
Chart illustrating the big RISK of ILLIQUIDITY
This from Ole S Hansen and his Commitmment of Traders report……
At the current price level most of the record short is under water:
As of yesterday the open interest has only fallen by 4% since April 30 => plenty more to come
Finally, here is an important run through of the dynamic hedging risk from: https://twitter.com/bennpeifert
Latest Market Insights
Quarterly Outlook Q3 2022: The Runaway Train
- Central banks' attempts to kill inflation is a paradigm shift, which could end in a deep recession.
Tangible assets and profitable growth are the winnersWith US equities officially in a bear market, the big question is where and when is the bottom in the current drawdown?
Understanding the lack of investment appetite among oil majorsThe everything rally seen in recent quarters has become more uneven, as its strength is driven by commodities in short supply.
The pressure is on as the wind leaves the sailsWith cryptocurrencies in sharp decline, are we entering a crypto winter or is the bear market a healthy clean-up of the crypto space?
Why the Fed can never catch up and what turns the US dollar lower?Many other central banks are set to eventually outpace the Fed in hiking rates, taking their real interest rates to levels higher than the Fed will achieve.
Bank of Japan: Swimming against the tideThe Japanese economy has gone from the age of deflation to rapidly rising prices in no time, leaving the Bank of Japan in a pickle.
Green transformation detour and bear market hibernationWith the impending risk of global econonomic derailment, we share the five things investors need to consider in this new half year.
Crisis redux for the eurozone?Whether there's going to be a recession in Europe or not, the path towards a stable economy will be agonizing.
Technical Outlook: Gold, Oil and a remarkable multi-decade perspective on EquitiesThe Nasdaq bubble pattern, USDJPY resistance, crude oil uptrend losing steam and the technical outlook for USD.
China: the train of new development paradigm left the station two years agoChina is transiting to a new development paradigm, as they are hit by deteriorating terms of trade, a slower global economy and an uncertain future while continuing attempts to contain the pandemic.