Alternative economic stories

London’s leading index fell by more than 250 points this morning as part of a global market sell-off after Wall Street suffered its biggest one-day fall on record.

The FTSE 100 started the day down 3.4 per cent at 7,083. It was the second day that markets in Europe and Asia fell. In Tokyo the Nikkei 225 index slumped 1,071.84 points, or 4.7 per cent, to 21,610.24m and in Paris the CAC 40 fell 3.1 per cent.

“This is fear rolling over itself, ” said Jingyi Pan, market strategist for IG Singapore.

Intensifying worries over the impact of rising inflation piled pressure on to markets across the world. Central banks respond to rising inflation by raising interest rates. This increases costs for businesses and households, curbing investment and spending and slowing economic growth. It also makes shares less attractive than other investments such as bonds.

We could also write this as: QE increased asset values. The return of inflation – an aim of QE – means less QE is required, even that it will be slowly reversed, as the US has already announced. Therefore asset values should give up their QE boost.

I wouldn’t say that either story is 100% true and complete but I’d take a stab at claiming the second one is better.

4 comments on “Alternative economic stories

  1. More like QE encouraged/forced large institutions to chase ‘low risk’ returns that could meet their asset liability modelling. Straight bond yields were now too low so the industry came up with so called risk parity products that offered “equity like returns with bond like risk”. Except of course they defined risk simply as low volatility and created the returns by leveraging bonds and credit. In fact they did pretty much exactly what they had done in 2006/7 that led to the crash in the first place!

    In a further search for yield they also ‘sold volatility’, picking up premium without accounting for the potential risk. It wasn’t counted as a risk of course because the only ‘official risk’ is volatility and correlation. Keep these low and nothing can go wrong. Honest. Regulators asleep at the switch. Also like 2007.

    As to proximate cause, look at the XIV Exchange Traded Note. Basically an inverse VIX volatility index, it was beloved of institutions but also mom and pop day traders in the US who all chased it up like a junior bitcoin trade the last two years. Problem is when you buy it, the ETN market maker essentially goes and sells vol, regardless of any underlying rationale, and VIX goes down. However, it is symmetrical; the day you try and get out of your XIV, possibly because VIX is rising as sensible investors exploit the skew in markets (punters were chasing the S&P with margin and derivatives so calls were expensive and puts cheap), then the trader has to buy vol in a market that is scrambling to buy protection.FOrced buyer of VIX and distressed sell of inverse VIX make a messy combination. This creates a spike in VIX and a meltdown in XIV – apparently -80% after the close. (Lots more on ZeroHedge who are now all over this btw)

  2. Don’t worry, the world’s leading economics guru is over this like a rash,throwing out half-digested theories like a man after drinking his age in pints of whisky

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