Volatility surprises are market moves outside the scope of expected volatility. They often bring to attention an underestimated type of risk. A paper by Aboura and Chevallier suggests that these volatility surprises transmit more easily across markets than return shocks. Moreover, the arising of unpredicted risk across markets seems to be cumulative.
Nicolas Veron explains European banking union and its acronyms. The two main pillars are the SSM (Single Supervisory Mechanism), run by the ECB, and the SRM (Single Resolution Mechanism), run by the SRB (Single Resolution Board). Before taking up its new role next month, the ECB will publish a stress test and an AQR (Asset Quality Review). The new framework is expected to ease the home bias of banking regulation and the sovereign-bank “doom loops”. Deficiencies include a lack of area-wide deposit insurance and insufficient resolution funds.
Asset purchase programs have left the U.S. banking system with USD2.9 trn in (mostly excess) reserves. Raising the target federal funds rate in this predicament relies primarily on increases in the interest rate paid on excess reserves. Moreover, in order to secure a sufficiently pervasive impact, overnight reverse repurchase agreements will likely play an important role. Their exact form will influence whether or not the target floor on money market rates will be “leaky”.
Dedicated EM exposure has surged by over 55% since 2007, with assets concentrated on few managers. A new BIS article points out that trading flows are correlated due to the widespread use of benchmarks. Moreover, EM asset prices and final investor flows have been pro-cyclical and mutually reinforcing. These patterns seem conducive to recurrent market dislocations.
A new paper estimates that U.S. economic data explain more than a third of bond price fluctuations on a quarterly basis. The economic data impact on daily fluctuations is much weaker. It grows with the time horizon because economic factors are more persistent than non-fundamental factors. The simple powerful message is that economic news flow is crucial (and probably underestimated) for identifying market trends.
Convenience yield represents the implied interest paid for borrowing physical commodity. Holding physical inventories carries benefits of flexibility for industrial consumers. The value of such inventories increases when scarcities arise. As a consequence, convenience yields help predicting future demand and price changes. A new Bank of Canada paper illustrates this for the crude oil market.
A new ECB paper explains key risk factors of shadow banking. First, if unregulated finance outgrows market size, tightening liquidity can escalate into runs and fire sales. Second, if shadow banks are operated by regulated banks they become a source of contagion. Third, and most importantly, if shadow banking focuses on regulatory arbitrage it erodes classical financial system safety nets.
Financial regulatory tightening implies to some extent mutation of systemic risk. Thus, elevated bank capital requirements raise incentives for regulatory arbitrage and shadow banking. Liquidity regulation and OTC derivatives reform inflate holdings of government securities and help accommodating high public debt. And the emergence of central banks financial stability mandates and macroprudential policies may create misplaced confidence in crude and untested macro management tools.
A paper by Bruno and Shin illustrates how global banks drive lending booms in local currency markets. Most importantly, they explain how currency strength fuels rather than curbs financial expansion in small and emerging economies, leading to escalating dynamics. Conversely, dollar strength can trigger a tightening spiral. Empirical evidence seems to support the point.
Developed market government bonds are viewed as “safe havens”, but in reality they have been prone to sudden outsized price declines, similar to FX carry trades, even during the past 20 years of modest inflation. Drawdowns are worse in poor liquidity. This empirical finding is not new but more relevant as bond yields have been compressed and institutional duration exposure has surged relative to banks’ market making capacity.
Macrosynergy is a London based macroeconomic research and technology company whose founders have developed and employed macro quantamental investment strategies in liquid, tradable asset classes, across many markets and for a variety of different factors to generate competitive, uncorrelated investment returns for institutional investors for two decades. Our quantitative-fundamental (quantamental) computing system tracks a broad range of real-time macroeconomic trends in developed and emerging countries, transforming them into macro systematic quantamental investment strategies. In June 2020 Macrosynergy and J.P. Morgan started a collaboration to scale the quantamental system and to popularize tradable economics across financial markets.
