“Ben Bernanke has set a trap for bond investors. The chairman of the Federal Reserve is likely on Wednesday to promise, again, to hold interest rates at a low level for a long time – but one day he will stop making that promise.
That is when millions of investors who have put their money into bonds will have to watch their ankles – that is when the steel trap springs shut.”
If I did not know better, it sounds more like a horror story than a op ed out of the Financial Times. Last Friday and yesterday, both, left my personal market radar a little bewildered. Friday risk off – Monday risk on. Tuesday risk off – Wednesday risk on ?
Tuesday was a traumatic experience. Some said it was the Bernanke retirement rumour and others said it was the cumulation of poor earnings, everything turned red for those 12 hours, except for US Treasuries. I have sadly concluded that Gold Cannot Be A Safe Haven Bet.
We are truly on dangerous ground. The inter-asset correlations have never been so high. But rather than blaming QE3 and the global easing happening around us, it would be quite instructive to be able to identify a culprit in this mess.
Lets examine the conditions since QE3. Half of traders I know are side lined. Their reason being, Bernanke has cauterised the fat tails on the curve and given a safety net to the too big to fail scenarios. This leaves the marketplace with only one big common outcome. A central bank dependent outcome. Big companies are safe; too bad if you are small.
Increasingly the bets are all skewed to one side as the open interest dies. There is only room for good news and none for the bad.
Take a look at the table of correlations I compiled below.
Everything is too correlated again. My comparative table below shows the QE3 correlations vs the pre QE era. Using 0.5 as a significant level, the cells are highlighted.
Its Risk On vs Risk Off for the past 4 years and it has been hard wired not only into our brains, its been hard wired into every single algorithmic model out there. For correlations are a big part of our lives and we cannot live without comparing one thing against another.
Note the alarming correlation now between the largest and most liquid instruments in the world. 10Y US Treasuries, the EUR currency and the US dollar. 10Y US yields are now hugely correlated with the EUR/USD. Risk on, 10Y yields up, EUR/USD up, same for the AUD/USD.
The only asset that is immuned seems to be WTI Crude/Brent Crude. We can blame the Arab Spring for that. Thus when I saw the price action on crude on Tuesday along with the 2 rapid S&P 500 meltdowns of last Friday and again on Tuesday, I do not believe the worst is over for the markets. There is an element of complacency in the air.
You see, the tables have turned now to men who will be gods. Bernanke, Draghi, London whales, Beijing Pandas and … Bill Gross. The Asian and EM growth stories are such feel good bedtime reading for a fund manager in Zurich but do not forget one thing. In a correlated world, the butterfly effect is amplified . Ever heard of theory that the flapping of a butterfly’s wings in South America could be causal in a tornado in the North ?
Yes. I know its risk-on today because it was risk-off yesterday. And my USD/JPY Ichimocci is doing well at 80.19 high, so far ! Feeling pleased but pensive and slightly schizophrenic from the fatigue of switching between risk on and risk off mode. Meanwhile another Tibetan self immolates in western China ( 2 in the past 2 weeks), Bernanke has not mentioned a 3rd term and Greece is given more time to bring us more pain.
My heightened sensitivity tells me somehow that the butterflies are coming soon.