Eerie Calm Shrouds Markets

The VIX, the volatility  of the S&P 500, is sometimes
touted as a “fear index.”
 Today is it extending its push below 10%, to fall to its lowest in nearly a quarter of a century.  
There has been four (Finland, Austria, the
Netherlands, and France) successive European election that did not produce a
victory for the euro-skeptics, who want to leave either the EU or EMU or both. 
 In Germany, the AfD has imploded and may be lucky to
be represented in the Bundestag after the national elections in September.
 A few months ago, some were talking about the possibility that Merkel is defeated in her bid for a fourth term as Chancellor.  Merkel and
the CDU have done well in the state
elections, and will likely do well in this weekend’s contest in NRW, the most
populous German state.  
Three-month implied
volatility in the euro, a common benchmark has broken below 7% to trade at its
lowest level since late 2014. 
 The low since at least 1999 was set
in 2014 near 4.75% and besides briefly in 2007, it has not traded below 5%.
   The fact that volatility has come off suggests participants are
less worried about macro-events and in terms of
the spot are anticipating range
The risk-reversal (skew in
the pricing of puts and calls equidistant from the money, in this case, 25 delta)
 has steadily moved to reduce the premium that is paid for euro puts. 
 In February, the premium for (three months) puts over calls swelled to more than
3%.  This was the most in five
years. The premium fell and today stands
near  0.25%.   Calls were briefly at a premium last February for the
first time since 2009.  
The yen, like the VIX, is
often thought of as some sort of fear
to think of the yen as a safe haven
may be misleading.  When anxiety is running high, and the pendulum of market sentiment swings toward fear
from greed, global investors are not rushing to buy Japanese stocks or bonds.
Instead, two things happen.  First, the US Treasury market is the safe haven.  Investors do in fact flock to
the depth, breadth, and security of the US Treasury market.  This exerts downward pressure on US interest
rates and weakens the yen through the differential.  Second, often in such
anxious moments, Japanese investors who typically exports their savings, stop
doing so.  Given Japan’s current account surplus (driven, incidentally, by
investment income (e.g., coupon payments, dividends), without the export of
savings to recycle the inflows, the yen “naturally” rises.  
In any event, the yen has
been weakening steadily since the middle of April. 
 On April 17, the dollar bottomed in front of JPY108.
  The US 10-year yield bottomed the next day near 2.16%.  The dollar
poked through JPY114.00 for the first time since the Federal Reserve hiked
rates in the middle of March.  The dollar has punched through the
downtrend line from the year’s high and March highs to approach the 61.8%
retracement objective of this year’s decline (~JPY114.65) 
Three-month implied yen volatility
is a little firmer today after reaching its lowest level in more than a year
yesterday a little ahead of 8.0%. 
 The correlation between the implied
yen volatility and the VIX (percentage change 60-day rolling basis) is near
0.35 today, the highest so far this year.  
Looking at the put-call
skew, one sees that the premium for dollar puts
has been sharply reduced since the end of February when it reached 2%. 
 The skew is now less than 0.5%, the least since late
January.  Historically, dollar puts (yen calls) often trade a premium.
 The thought was that Japanese corporations who have dollar receivables
hedge in the options market by buying dollar puts (yen calls).  One thing
the options market may be telling us is that participants are less concerned
about a weaker dollar.  
The price of gold has fallen
for the past three weeks.
  With today’s losses, the yellow
metal is back to levels seen in mid-March when the Fed last hiked.  It
fell through the 200-day moving average last week ($1250) and appears to be making a decisive break of the 100-day
moving average (~$1224). Gold appears headed toward a test on the $1180-$1210
area, which may help shape the medium term view.  
One need not be a hardcore
contrarian or an options trader to take notice of the markets’ calm.  
Minsky warned that due to the perverse
dynamics and incentive structure, stability could
itself can fuel instability.   The French and UK elections next month are interesting but unlikely to shake up investors.
   Success is an aphrodisiac,
and the former Socialist Macron is drawing candidates that want on his banner.
 In the UK there is little doubt that May will lead the Tories into
victory.   The German election in September is Merkel’s to lose.  
Many observers seem to
recognize that Italy’s election next year may be the next important European
 However, it is a year away.
 Perhaps Italian banks are the “ultimate” risk asset.  An
index of Italian bank shares is up by
more than a third since the end of February.  Yesterday, it reached its
highest level since April 2016.  
Geopolitics can always come
back to bite. 
 Consider that just yesterday, for
the first time this year, a Russian jet violated Estonia’s airspace.
 Reports indicate that it did so around half a dozen times last year.
 Russia’s foreign policy agenda may not be dependent on who occupies the
US White House. Recall, Russia invaded Georgia in 2008 when George W Bush was
president.  General Eisenhower was president when the Soviet Union invaded
Hungary.   Johnson, who had projected US power in Vietnam, the Middle East, and the Caribbean when the Soviet Union
invaded Czechoslovakia.  
Russia’s asymmetrical
warfare has been successfully deployed on
what it calls the near abroad.
  It borders.  It has harassed the Baltic States, like
Estonia.  The airspace incursions are a subject of diplomatic protests,
but not an escalation of tensions.  Where is that line?  Russia can
find a small border town in a Baltic country that the majority of people speak
Russian and may even have Russian passports.  Isn’t this a logical
“next move” in the chess game Putin is playing in central and eastern

Meanwhile, the Trump
Administration is pursuing less antagonistic policies toward China. 
Remember, after the electoral college victory, Trump spoke
to the president of Taiwan, and even questioned the US one-China policy. Trump
has not levied a 25% tariff on Chinese goods.  China has not been cited as a currency manipulator.  The
US may also be backing off from challenging China in the South China Sea.
 The New York Times reported that the Department of Defense had rejected the last three proposals for
freedom of navigation operations.  These essentially are a display of US
force in waters that some countries, such as China, claim are theirs.  

The point here is to note
the extremely low levels of anxiety in the market.  
The VIX, US Treasuries, gold and the
volatility of the yen and the euro, all are pointing in the same direction.
 There is not the reason it cannot
continue, and this should not be read as
a call that the Sky is Falling.  It is meant to show how extreme the calm
is, and remind ourselves, that large moves typically do not happen when
volatility is high, and investors are
anxious and nervous.  It happens when things are calm, and investors see TINA (there is no alternative).  
Geopolitics and the divergence of policy, and asset/liability and duration
mismatches have not gone away.   It is a reminder that we are often lulled into complacency just before
being shocked by how treacherous things really

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