COLUMN-As eerie calm returns to

markets, have investors given up

hedging? - McGeever - Reuters News
12-Jun-2018 12:01:00 AM
The opinions expressed here are those of the author, a columnist for Reuters
By Jamie McGeever
LONDON, June 11 (Reuters) - Perhaps the most remarkable aspect of what has been a bumpy ride for world
financial markets this year is how stubbornly low volatility is. It's as if investors have given up on hedging, which is
exactly what appears to be happening.
Benchmark measures of implied volatility across major stocks, bonds and currency markets are historically low,
despite the ECB preparing to join the Fed in tightening policy, Italy's bond market in turmoil and surging global trade
war fears.
If that wasn't enough, the G7 pantomime at the weekend shows that the rules-based international order that has
provided the political and economic framework for financial markets over the last 40 years is facing an existential
crisis.
But almost all the recent bursts of volatility, in Turkey, Argentina as well as Italy, have remained localised and the
spillover to broader markets has been negligible. Even the S&P 500's "volmageddon" episode in February was short-
lived.
This is partly because, at the macro level, the world economy continues to hum along quite nicely. Global growth is
north of 3 percent and there's little sign of it slowing to any significant degree.
The latest Commodity Futures Trading Commission data show that hedge funds and speculators maintained a short
position in VIX futures contracts, essentially betting on lower volatility in the S&P 500 over the coming month.
The net short position was trimmed a bit to 36,189 contracts from 44,380 the week before, but these are figures for
the week to Tuesday, June 5. The VIX has since fallen further, trading with an 11 percent handle for the first time
since late January.
The VIX index is now at 12.5, below its median over the last five years of 14.6. Only four months ago it had its biggest
rise in history on fears that accelerating U.S. wage growth would force the Fed to jack up interest rates far more
aggressively than investors had bargained for.

The fact it's come back down so far so quickly suggests investors still have very little appetite to protect their
positions and portfolios via the options market.
"Have people given up hedging? Hedging seems to be a bad idea because you just end up losing money even on the
outcomes you're hedging against, such as Brexit or Donald Trump getting elected," says Citi's Matt King. "Up until
now, markets have always bounced straight back."
It's a similar picture, although not quite as stark, in currencies and bonds.
Deutsche Bank's currency volatility index is currently at 7.6, below the average over the last five years of 9.3, and the
one-month Mermove index of implied volatility in U.S. Treasuries 59.6, compared with the five-year average of 68.3.

HERD MENTALITY
Central banks' quantitative easing has shaped this mentality as investors have come to assume that central banks
will step in at the first sign of market turbulence or economic fragility, the so-called 'central bank put'.
The S&P 500 reached an all-time high of 2,872 points on Jan. 26 then lost more than 10 pct in the following two
weeks as the "volmageddon" shock ripped through world markets. But recovery has been steady, and it closed within
100 points of that peak on Friday. The booming tech sector boom lifted the Nasdaq to fresh highs on Friday too.
Trouble is, the herd mentality it has fostered means the entire market has the same volatility trade on. Selling and
being short volatility has been such a money-spinner, few are willing to go the other way. At least not yet.
There's no shortage of risks to hedge against, but that may be part of the problem. Hedging against every potential
risk is impossible, and prohibitively expensive. So if you think the central banks have your back, why bother?
That's been the story of the first half of the year, even as the Fed has continued raising rates and the 10-year
Treasury yield finally broke above 3 pct for the first time since 2011. Will it continue to be so in the second half of the
year?
Citi's King is sceptical, as are analysts at Morgan Stanley. They reckon implied volatility is too low and the return (or
carry) from selling vol offers an insufficient cushion for when volatility does turn higher. They advise going long
volatility.
A major variable will be the length of the economic cycle. Many analysts think the U.S. economy, with the labour
market its tightest in 50 years, by some measures, will soon roll over. But others, like those at Blackrock, believe the
growth cycle can continue for years to come.
"Bottom line, selling vol on equity, credit and rates looks quite challenging despite positive carry, unless one is very
optimistic on the longevity of the cycle," Morgan Stanley wrote in a report last month.

(Reporting by Jamie McGeever

Editing by Mark Heinrich)
(( jamie.mcgeever@thomsonreuters.com ; +44 (0) 207 542 8510; ))

(c) Copyright Thomson Reuters 2018. Click For Restrictions - https://agency.reuters.com/en/copyright.html

Keywords: GLOBAL-MARKETS/VOLATILITY (COLUMN)

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