Leveraged Exchange Traded Funds have become a significant factor in the U.S. equity market. According to a new Federal Reserve discussion paper their mechanical rebalancing rules can reinforce or even escalate large directional moves in the stock market, both through their own transactions and other market participants’ front running.
The Federal Reserve Bank of New York continues to highlight the latent risk of fire sales in the tri-party repo market. The danger arises from an incentive to liquidate collateral in case the solvency of a dealer is in doubt. The risk is enhanced by the vulnerability of the main cash lenders intri-party repos, money market mutual funds and security lenders, to liquidity pressure. Policy tools to contain such an event are limited.
Cross-asset correlation has remained high in recent years, despite the post-crisis decrease in volatility. Typically, correlation surges during financial crises, when macro risk factors dominate across markets. However, J.P. Morgan’s Marko Kolanovic and Bram Kaplan show that there has also been a secular increase in cross-asset correlation since 1990, due probably to globalization of markets, risk management and alpha generation techniques.
Securities held by VaR (Value-at-Risk)-sensitive institutional investors, such as banks, are prone to escalatory selling pressure after an initial shock, in particular if they make up a substantial portion of the portfolio. Nikolaos Panigirtzoglou underscores that the Japanese government bond market has already demonstrated its proclivity to such ‘VaR shocks’. Also on a global scale government bond yields may overtime become more vulnerable, as one of the unintended consequences of quantitative easing.
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.
