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(Bloomberg View) -- To investors of a certain age, the phrase "portfolio insurance" is sure to conjure up nightmares. That's because the trading strategy, which basically entailed using lots of leverage to buy stock-index futures to hedge positions, is blamed for exacerbating the 1987 market crash. Now, one of JPMorgan's most influential market strategists is comparing the risks of some popular strategies today to that one from 30 years ago.
It's probably no coincidence that U.S. stocks gave up their gains and that measures of volatility spiked at about the same time news of the note from JPMorgan derivative strategist Marko Kolanovic hit the wires early this afternoon. In it, Kolanovic says strategies that boost leverage when volatility declines, such as option hedging, commodity trading advisers (which is a bit of a misnomer since they have less to do with commodities than they do with trading options and futures), and risk parity accounts (which is basically a strategy that weights asset classes based on riskiness and volatility) "share similar features with the dynamic 'portfolio insurance' of 1987." Kolanovic goes on to say that as these strategies have grown in popularity, the potential fallout from everyone trying to exit the trades at once has become much bigger.
So, what could be the trigger? To Kolanovic, the big risk is a reversal in volatility, which has plunged in almost all asset classes, raising concerns about too much complacency permeating markets. The fact that volatility is at such historically low levels "indicates that we may very close to a turning point," Kolanovic writes. It's hard to know exactly how much money is at stake, but estimates for risk parity funds vary from $150 billion to $500 billion, while there's a record $350 billion in assets tied to managed futures, including CTAs that invest in futures contracts.
THE END OF FINANCIAL REPRESSION IS IN SIGHT -- MAYBEA milestone was passed this week when one-month Treasury bill rates rose above 1 percent for the first time since 2008. That may not seem like much until you consider that the rate averaged a paltry 0.07 percent between 2008 and 2016 as the Federal Reserve adopted a zero rate monetary policy to help the economy recover from the worst recession and financial crisis since the Great Depression. That was good for borrowers and the super-rich who have benefited from the second-longest bull market in stocks in history, but not so good for ultra-conservative savers. Now that the Fed is raising rates again -- albeit very slowly -- the risk-averse can now finally earn a rate of return. The average rate on a one-month certificate of deposit is 1.29 percent, up from 0.14 percent as recently as 2015. Don't get too hopeful for the return of the days of 3 percent CD rates. The turmoil in Washington has made bond traders less confident that the Fed will push rates much higher from here as the Trump administration finds it harder to enact its pro-growth, business-friendly fiscal agenda.
GOLDMAN SACHS SEES GREEN SHOOTS FOR OILOil is doing its hardest to regain the $50 a barrel level that it last reached in late May. After falling to about $42.50 in June, it has since rebounded to about $49 as suppliers step up their rhetoric about clearing an overhang of supply. Count Goldman Sachs as one of the believers. In a research note titled "Green Shoots in the Oil Market," the firm says recent data showing inventories may be on the decline, which coupled with the rebound in prices "raise the question of whether the oil market is at an inflection point and set to break to new year-to-date highs." The Energy Information Administration reports that U.S. crude inventories declined by 7.21 million barrels last week to the lowest level since early January, according to Bloomberg News' Jessica Summers. Kuwait joined the U.A.E. in promising to pump less oil after Saudi Arabia called on OPEC producers to cut more supply. “This market really has a lot going for it at the moment," said John Kilduff, a partner at hedge fund Again Capital in New York. "There is an impression that we’re coming into balance finally and it’s driven by this pretty steep decline in U.S. crude oil inventories."
THE SWISS FRANC MAKES A MOVEThe dollar is tumbling and the euro is soaring, but the most interesting development in the foreign-exchange market this week may be what's happening with the Swiss franc. The Swissie, as it's known among traders, has inexplicably tumbled. The 2.09 percent decline the past three days against a basket of developed-market currencies as measured by Bloomberg Correlation-Weighted Indexes is the most in two years. What's more, it's now the weakest against the euro since the Swiss National Bank abandoned its currency cap more than two years ago. Historically, the franc has been a haven in times of global turmoil. So, does the drop mean that traders have suddenly developed animal spirits when it comes to the global economic and geopolitical outlook? That's unlikely, say strategists, who are struggling to provide a reason for the weakness. The best explanation is that it's more a reflection of euro strength and the more benign outlook for euro-zone politics. For the economy's sake, Swiss officials would like a weaker franc, which has been in high demand since the financial crisis. Earlier this week, SNB President Thomas Jordan said in an interview with Le Temps that the franc is "significantly overvalued." "For this reason we maintain our monetary policy of negative interest rates and interventions if needed," the newspaper quoted him as saying.
EMERGING MARKET BONDS POSED FOR SECOND WINDWorried that you may have missed out on the big rally in emerging market bonds? Fear not; you may still get a chance. Pressure is growing on central banks in developing nations to cut interest rates more aggressively as inflation eases and the Fed takes a gradual approach to policy change. That's reducing the need for the high borrowing costs that deter capital outflows and protect emerging-market currencies, according to Bloomberg News' Srinivasan Sivabalan, Aline Oyamada and Paul Wallace. Looser monetary policy is a potential boon to already surging sovereign and corporate bonds in emerging markets, which in recent weeks revived a rally that sent both dollar-denominated and local-currency debt gauges to all-time highs. "Now that inflation is coming down and currencies have stabilized, you are seeing the monetary policy in many emerging markets shifting toward an approach of lowering rates, or at least stabilizing rates," which is good news for bonds, said Steven Oh, the global head of credit and fixed income at PineBridge Investments.
TEA LEAVESDid the U.S. economy really rebound from a subpar first quarter? The answer to that question will be revealed Friday when the Commerce Department releases its first look at gross domestic product for the second quarter. Based on the median estimate of economists surveyed by Bloomberg, GDP likely expanded at a 2.5 percent annualized rate, up from the first quarter's 1.4 percent pace. To be sure, some of the upswing owes to such temporary factors as low heating bills, delayed tax refunds and volatility in inventories, according to Bloomberg News' Patricia Laya. If the pickup is going to extend into the second half of 2017, faster household income creation is a must, according to the economists at Bloomberg Intelligence. That should happen as slack in the labor market dwindles, but that has yet to occur, the economists wrote in a research note.
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