A Banca d’ Italia paper reminds us that the market impact of economic data surprises depends on the state of the economy and forecast diversity. In particular, the surprise impact tends to be greater, when predictions are tightly clustered around a ‘consensus’. Conversely, uncertainty seems to help preparing markets for shocks.
There is evidence for a double relation between volatility and returns in equity markets. Longer-term fluctuations of volatility mostly reflect risk premiums and hence establish a positive relation to returns. Short-term swings in volatility often indicate news effects and shocks to leverage, causing to a negative volatility-return relation. Distinguishing the two is important for using volatility as a predictor of returns.
Empirical analysis suggests that equity and bond returns in international markets are driven mostly by shocks to expected future real cash flows. Moreover, they interact with mutual fund flows. In particular, there is evidence of short-term “trend chasing” and overreaction. Bond market returns and flows are also jointly driven by U.S. interest rate shocks.
A new ECB paper explores macroeconomic indicators for banking and currency crises over the past 40 years. Banking crises arose mostly in constellations of [i] low credit-deposit spreads and high short-term rates (over 11%) or [iii] high credit-deposit spreads (over 270 bps) and flat or inverted yield curves. Housing price growth has also been a warning signal. Currency crises ensued from exchange rate overvaluation (more 2.7% above trend) and high short-term interest rates (over 10%).
Two recent papers contribute to forecasting inflation in a world of convergent policy regimes and integrated economies. The first emphasizes the distinct effects of shocks to aggregate demand, supply, and monetary policy. The second explains why country inflation usually corrects deviations from trends in the rest of the world. Predominantly inflation has become a global force.
Financial markets often disregard the fundamental difference between volatility (the magnitude of price fluctuations) and risk (the probability and scope of permanent losses). Standard risk management and academic models rely upon volatility alone. Alas, this reliance can induce an illusion of predictability and excessive risk taking. Indeed, low volatility can indicate and even aggravate the risk of outsized permanent losses.
Empirical analyses document the success of trend following strategies in global equity and FX markets over the past 30 years. Stylized trend following delivered higher risk-adjusted returns with smaller maximum drawdowns when compared with other conventional strategies. It also provided value as a hedging strategy.
A new CGFS paper suggests that bank regulatory capital and liquidity changes may [i] reduce liquidity in money markets, [ii] create steeper short-term yield curves, [iii] weaken bank arbitrage activity, and [iv] increase reliance on central bank intermediation. Profit opportunities may arise for non-banks.
A BOJ paper proposes an affine terms structure model for bond yields under consideration of the zero lower bound. It estimates the contribution of [i] expected real rates, [ii] real term premia, [iii] expected inflation rates, and [iv] inflation risk premia. In the U.S. yields have been driven mainly by expected real rates and real term premia in recent years. In Japan inflation expectations and inflation/deflation risk premia have played a greater role.
A new BIS paper provides important lessons for EMFX carry trades, using Latin America as a case study. First, FX carry opportunities depend on market structure and regulation. Second, observed carry typically contains a classic interest rate differential and an arbitrage premium that reflects the state of on-shore and off-shore markets. Third, liquidity shortages and FX proxy hedging constitute major setback risks.
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.
