Monthly Archives: July 2014

Quick Update on Market Risk……

Ok we have had our fair share of event risk  so far this year. Ukraine, Israel, Portugal  to name but a few….and  we now have Yellen telling us that the Fed may hike the rates earlier than forecast. And guess what ? The Vix is still trading in the low bottom quartile.vix

Though my shock Index  (ratio of  VIX volga and Vix over  21 days) did venture above its long term median value on the back of the Portugal  news, all  of my risk indicators remain  well entrenched in risk seeking  territory….


My  2-state Markov model continue to sell volatility…I am not sure I would but I can t fault the outcome of the model so far.


Bearing in mind the above I am  still  a bit quizzical  as of why risk is  trading so low. We are getting  indeed very little reaction from events that  once would have sent the VIX flying into the 20 to  25% range . The only rationale I have is that Investors are now accepting that  growth is significantly  taking hold and therefore investment flows are  logically channelling  into risky assets and carry trades. Also there  is  now a strong understanding  that central banks   are determined in doing  whatever is necessary to support growth and rid of systemic risk. This clearly  has a strong dampening effect  on any risk spikes, but lets not get too complacent about it…

Is The Fed Changing Its View About Inflation ?

Yesterday in her  Semi-annual Monetary Policy Report to the Congress,  Chairman  Janet Yellen  stated the following: “If the labor market continues to improve more quickly than anticipated by the Committee… then increases in the federal funds rate target likely would occur sooner and be more rapid than currently envisioned.”  However Treasury yields  have barely moved and the dollar appreciation  again the Greenback remained muted . The Euro depreciated only by 0.6% against the US Dollar since her speech.  As shown from the chart below though the dollar against a broad basket of currencies is fairly well priced this is not the case for 10-year yields. US 10 year yierld traded weighted Against all odds, Yellen  seems to have managed to contain market expectations yet again. This is quite outstanding when one looks at the hard data. Unemployment is clearly below the 6.5%  Fed target level. Also the rise in industrial production is quite telling of  an even lower unemployment rate in the months to come. unemployement USINDPRO

It is true that we have not yet seen much wage inflation in the us. The annual rate of increase in the average hourly earnings remains below 2% as shown below.  Wages remain dampened by the spare labour capacity. average earnings Clearly the Fed has accepted to remain behind the curve for quite a while  so  as not  to compromise any renewed  growth  in the US. The current low level of the Fed fund rate is a good illustration of  this. Fed Fund Contributing to a generally  dim view on the US economy by Fed members  could be that many forecasting models use 2×10 spreads as an input to forecast GDP. The abnormally ultra-low fed fund and therefore current steepness of the curve  could contribute to why  the Fed  growth forecasts may not be as accurate as should be.  After all even the IMF got it wrong with its growth forecast for the UK. 2x10It is now noticeable that over the last few months,  Inflation has crept  above the 2% target of the fed as indicated by the below chart. This is not surprising as trend in consumerism and aptitude of  price increase  is somehow function of  employments and wages earned. Though arguably not yet at an alarming level it will be interesting to watch out how the Fed react to further developments. US CPI So is the Fed starting to worry about inflation ? Plotting a Word Cloud of Yellen’s  speech it is indeed quite clear that Inflation is the central issue …..   yellen speechBearing in mind the above  it will be interesting to watch out for changes in the pattern of the inflows/outflows in US mutual funds. My thought is that we could see a resuming of the exit of bond products which was compromised by the ultra dovish tone adopted by Yellen when she took office. As mentioned in my previous post , the relative inflow/outflow in US versus foreign equities  could also have a perverse effect on the valuation of the US Dollar. High rates are not necessarily a long term driver of currency , capital flows are more important.  As a remainder of the current trends in US mutual funds  below are  couple of charts of my previous post. They show the distribution of the inflows/outflows in US mutual funds by asset class since the beginning of the year and the cumulative   flows in domestic versus foreign equities products since 2007. distribution inflows 2014cumulative flows I’ ll stick to my Long global equities and short dollar view…..

US Mutual Funds Flows Update: Investors Still Favouring International Equities

As it has been a while  since I have posted something and my broken arm is no longer a valid  excuse , I thought I would provide an update on  trends  in US mutual funds flows. To my surprise, bearing in mind the current geopolitical risks,  there has not been much change over the last few weeks. US investors have held onto  their preference for international equities whilst staying shy from the US stock markets. Also the trend of inflow into bonds   remained despite growing expectation of the Fed becoming more hawkish down the line. The map below shows the T-stats of the inflow/outflows across different time periods.


Clearly the dovish tone adopted by the Fed  has helped both the trend in equities and also bonds.  The question is how long  can this last ? Clearly the strengthening  observed in the US job market demonstrates that significant growth has rooted. Down the line this will create an issue for the fed, as managing rate expectations  whilst turning away from a dovish stance may prove challenging.  To me the most interesting point of all  is how US investors voted with their money. As can bee seen from the below charts they have stayed well away from US equities whilst investing in Foreign equities. In fact out of the US$ 133 bn invested in US mutual funds  44 %  (US$ 59 bn) went into  foreign equities  so far this year, whilst  US$ 5bn came out from US Stocks funds.

cumulative flows  distribution inflows 2014

As said in my previous posts I believe that what we are seeing could be a good explanatory variable as of  why the dollar has been so weak and particularly against the EURO despite the monetary expectation in Europe and the US. Bearing in mind the current market positioning and central bank flows it may well be that the  EURUSD is currently undervalued….