This podcast episode features a conversation with Charlie McElligott, a cross-asset macro strategist at Nomura. The discussion revolves around recent market volatility, particularly the significant selloff and shifts in volatility dynamics. McElligott explains how the flattening of the skew, a measure of demand for downside versus upside protection, and the bid on volatility of volatility (Vol of Vol) indicated growing concerns in the market. He notes that the Federal Reserve’s policy changes have played a crucial role in these dynamics, especially the transition from quantitative easing (QE) to quantitative tightening (QT), which created a negative wealth effect.
The conversation touches on various complex market strategies, such as the short volatility trade, and how these have been impacted by recent macroeconomic catalysts, including labor data surprises and the Fed’s tightening policies. McElligott also discusses the implications of the Bank of Japan’s policy shifts on global markets, particularly the unwinding of the Yen carry trade.
Towards the end, the conversation shifts to risk management, with McElligott highlighting the challenges faced by market participants in the current volatile environment.
00:03
Speaker 1
Bloomberg Audio Studios, podcasts, radio news.
Bloomberg Audio Studios, podcasts, radio news.
00:10
Speaker 2
Hi are you good to see you again? Nice, good to see Thank you guys for having me.
Hi are you good to see you again? Nice, good to see Thank you guys for having me.
00:16
Speaker 3
No, thank you for coming anything going on this weekly?
No, thank you for coming anything going on this weekly?
00:20
Speaker 2
Yeah, you know, we’ve been feeling stuff, seeing stuff for a while. But you know, by the end of last week it was like, this is getting pretty hectic and I had to drive like eight hours each way up to New Hampshire. I got back Sunday, I was like, I got to start this right now.
Yeah, you know, we’ve been feeling stuff, seeing stuff for a while. But you know, by the end of last week it was like, this is getting pretty hectic and I had to drive like eight hours each way up to New Hampshire. I got back Sunday, I was like, I got to start this right now.
00:37
Speaker 3
I did a deadlift one Jimmy, Okay, go.
I did a deadlift one Jimmy, Okay, go.
00:44
Speaker 1
Uh marches.
Uh marches.
00:45
Speaker 3
This isn’t after school Special, except.
This isn’t after school Special, except.
00:46
Speaker 1
I’ve decided I’m going to base my entire personality going forward on campaigning for a strategic pork reserve in the US.
I’ve decided I’m going to base my entire personality going forward on campaigning for a strategic pork reserve in the US.
00:52
Speaker 2
Where’s the best with imposta?
Where’s the best with imposta?
00:54
Speaker 1
These are the important question? Is that robots taking over the world.
These are the important question? Is that robots taking over the world.
00:57
Speaker 3
No. I think that like a couple of years, the AI will do a really good job of making the Odd Lots podcast. And people say, I don’t really need to listen to Joe and Tracy anymore.
No. I think that like a couple of years, the AI will do a really good job of making the Odd Lots podcast. And people say, I don’t really need to listen to Joe and Tracy anymore.
01:08
Speaker 2
We do have.
We do have.
01:10
Speaker 3
The perfect welcome to lots more where we catch up with friends about what’s going on right now.
The perfect welcome to lots more where we catch up with friends about what’s going on right now.
01:17
Speaker 1
Because even when Odd Lots is over, there’s always lots more.
Because even when Odd Lots is over, there’s always lots more.
01:21
Speaker 3
And we really do have the perfect guest. So would you say that like stuff was already getting a little hairy last Like, what were those early signs. Was it just Wednesday during defense decision or what were what were you starting to see?
And we really do have the perfect guest. So would you say that like stuff was already getting a little hairy last Like, what were those early signs. Was it just Wednesday during defense decision or what were what were you starting to see?
01:35
Speaker 2
Well, there’s different time horizons, for sure, and I think one of the things that we absolutely have to discuss is the signal from Skew Right Skew is this you know, relative measure of kind of demand for downside versus demand for upside, which is, you know, something that we can come back to later, but without a doubt, when you began to see Skew, you relentlessly stay bid. When you begin to see the volatility of volatility, stay so bid even as stocks were, you know, trying to kind of stabilize after some of the recent death by papercut of geopolitical and kind of earnings disappointments. So you know, obviously the growth dynamic is a big part of this too, as far as you know, the labor data finally catching down. But you know, it told you that there was this you know, grab into tails and you know a big part of the messaging that I’ve been giving since March April period was that we had been living in this really interesting world where in the end of April SKW was extremely extremely historically all time kind of flat levels, meaning that it was really representative of two things. Extremely low demand for downside extremely high demand for.
Well, there’s different time horizons, for sure, and I think one of the things that we absolutely have to discuss is the signal from Skew Right Skew is this you know, relative measure of kind of demand for downside versus demand for upside, which is, you know, something that we can come back to later, but without a doubt, when you began to see Skew, you relentlessly stay bid. When you begin to see the volatility of volatility, stay so bid even as stocks were, you know, trying to kind of stabilize after some of the recent death by papercut of geopolitical and kind of earnings disappointments. So you know, obviously the growth dynamic is a big part of this too, as far as you know, the labor data finally catching down. But you know, it told you that there was this you know, grab into tails and you know a big part of the messaging that I’ve been giving since March April period was that we had been living in this really interesting world where in the end of April SKW was extremely extremely historically all time kind of flat levels, meaning that it was really representative of two things. Extremely low demand for downside extremely high demand for.
02:55
Speaker 3
Upside downside protection. Right, all right, just want just for listeners to make sure.
Upside downside protection. Right, all right, just want just for listeners to make sure.
02:59
Speaker 2
Right, and kind of when you look at the forwards and in my view, is this skew really on a longer horizon, like decades type horizon to me is representative of, you know, what’s the actual risk taking, risk appetite backdrop, Meaning it’s heavily related to central bank policy. So for instance, in the kind of q E era where you know, the FED was trying to incentivize a wealth effect, right, they wanted you to be leveraged long assets, and in that because that’s economically you know, virtuous right consumption, you know, paper wealth effect all those things, you were leverage long risk assets. SKEW is deep because you had something to hedge. But after the events that created that, you know, idiosyncratic stacking of stuff from the FEDS inflation rethink in twenty nineteen, the flexible average inflation targeting the tariffs impact into COVID, into the supply chain disruption, into the stimulus plus you know, the tectonic stimulus, which had never been tried before. In addition to the unprecedented quantitative easing, you finally had this escape velocity inflation event, which then forced the FED behind the ball, and it forced them to have to tighten in a place that we’ve never seen before. And QT right as opposed to QE. They needed to create a negative wealth effect because they could only impact demand side inflation, and with demand side inflation being the only lever that they could pull, they had to create a negative wealth effect. And in that environment, skew went extremely flat. You didn’t own underlying They were telling you to get out of risk assets. They were telling you to park in cash. Cash isn’t at the money put right, it’s a hedge. There. You were able to sleep at night collect three four five percent. At times, the only tail that you were afraid of was no left tail, was no crash downside event. It was about missing the right tail. It was a missing the rally, the upcrash, the upcrash. So the last two years, you know, kind of prior to the last six months let’s say the last two years, we were in this super bizarre place to a lot of people, counterintuitive with positive spot meaning kind of underlying market VALL correlation. You know, VALL was going higher as the market was rallying because people didn’t have the exposure on we’re being forced to chase, right. Data was beginning to soften, Inflation was starting to come off the FED. It was kind of opening the door to the end of the tightening cycle, and you were under positioned, so you’re grabbing into calls, and that same positive spot VALL correlation on selloffs meant that VALL would grind lower because you were in this really virtuous backdrop for VALL selling, right, So down days were opportunities to sell VALL. And at the core of everything that has kind of happened over the last week, in particular the last few days really has been about that kind of come to Jesus moment for the short VALL trade of the past two years. So you know, you had this dynamic where flat skew is a feature of quantitative tightening, and at the march kind of extremes we started beginning to see skew steep and again pretty impulsively, and that was the signal that you know, we were going to resume back to this prior world of a negative spot vult correlation.
Right, and kind of when you look at the forwards and in my view, is this skew really on a longer horizon, like decades type horizon to me is representative of, you know, what’s the actual risk taking, risk appetite backdrop, Meaning it’s heavily related to central bank policy. So for instance, in the kind of q E era where you know, the FED was trying to incentivize a wealth effect, right, they wanted you to be leveraged long assets, and in that because that’s economically you know, virtuous right consumption, you know, paper wealth effect all those things, you were leverage long risk assets. SKEW is deep because you had something to hedge. But after the events that created that, you know, idiosyncratic stacking of stuff from the FEDS inflation rethink in twenty nineteen, the flexible average inflation targeting the tariffs impact into COVID, into the supply chain disruption, into the stimulus plus you know, the tectonic stimulus, which had never been tried before. In addition to the unprecedented quantitative easing, you finally had this escape velocity inflation event, which then forced the FED behind the ball, and it forced them to have to tighten in a place that we’ve never seen before. And QT right as opposed to QE. They needed to create a negative wealth effect because they could only impact demand side inflation, and with demand side inflation being the only lever that they could pull, they had to create a negative wealth effect. And in that environment, skew went extremely flat. You didn’t own underlying They were telling you to get out of risk assets. They were telling you to park in cash. Cash isn’t at the money put right, it’s a hedge. There. You were able to sleep at night collect three four five percent. At times, the only tail that you were afraid of was no left tail, was no crash downside event. It was about missing the right tail. It was a missing the rally, the upcrash, the upcrash. So the last two years, you know, kind of prior to the last six months let’s say the last two years, we were in this super bizarre place to a lot of people, counterintuitive with positive spot meaning kind of underlying market VALL correlation. You know, VALL was going higher as the market was rallying because people didn’t have the exposure on we’re being forced to chase, right. Data was beginning to soften, Inflation was starting to come off the FED. It was kind of opening the door to the end of the tightening cycle, and you were under positioned, so you’re grabbing into calls, and that same positive spot VALL correlation on selloffs meant that VALL would grind lower because you were in this really virtuous backdrop for VALL selling, right, So down days were opportunities to sell VALL. And at the core of everything that has kind of happened over the last week, in particular the last few days really has been about that kind of come to Jesus moment for the short VALL trade of the past two years. So you know, you had this dynamic where flat skew is a feature of quantitative tightening, and at the march kind of extremes we started beginning to see skew steep and again pretty impulsively, and that was the signal that you know, we were going to resume back to this prior world of a negative spot vult correlation.
06:24
Speaker 1
So we are speaking with Charlie mcgelligate. He is, of course, the cross asset macro strategist at Nomora and the guy we like to call when we need to start talking about Greek letters and things like delta hedging and all of that. Charlie, what are we calling the sell off? I came up with an idea that I’m I’m quite proud of.
So we are speaking with Charlie mcgelligate. He is, of course, the cross asset macro strategist at Nomora and the guy we like to call when we need to start talking about Greek letters and things like delta hedging and all of that. Charlie, what are we calling the sell off? I came up with an idea that I’m I’m quite proud of.
06:43
Speaker 2
Give it to me. I mean, it sounds like fodder for my subject, Lineman.
Give it to me. I mean, it sounds like fodder for my subject, Lineman.
06:47
Speaker 1
Yes, yes, you can have this one volma fedian and the valma is AI, so it’s volatility ai fed And yet that’s good.
Yes, yes, you can have this one volma fedian and the valma is AI, so it’s volatility ai fed And yet that’s good.
06:59
Speaker 3
That really rolls.
That really rolls.
07:00
Speaker 1
Yeah, I know, meta, it’s going to be useful.
Yeah, I know, meta, it’s going to be useful.
07:05
Speaker 2
Multivariate. Yeah, I mean, look, there’s you know we spoke about, you know, the macro catalyst that kind of set off this event, you know, and a lot of people I think, you know, way off the mark with regards to oh it’s you know, it’s yen carry unwined or oh you know, yeah.
Multivariate. Yeah, I mean, look, there’s you know we spoke about, you know, the macro catalyst that kind of set off this event, you know, and a lot of people I think, you know, way off the mark with regards to oh it’s you know, it’s yen carry unwined or oh you know, yeah.
07:22
Speaker 1
Wait, talk more about that, because I see lots of people saying it’s the yen carry unwined, So the idea that people were borrowing in yen at a low interest rate and then investing that in risk assets. But if that was happening on a scale which would cause the market moves that we’ve seen in the past couple of days, I would have thought that you would see more of an impact in stuff like credit, right, like ig or high yield, and that hasn’t really happened because my impression was always like a lot of targets of the carry trade were actually in credit right.
Wait, talk more about that, because I see lots of people saying it’s the yen carry unwined, So the idea that people were borrowing in yen at a low interest rate and then investing that in risk assets. But if that was happening on a scale which would cause the market moves that we’ve seen in the past couple of days, I would have thought that you would see more of an impact in stuff like credit, right, like ig or high yield, and that hasn’t really happened because my impression was always like a lot of targets of the carry trade were actually in credit right.
07:54
Speaker 2
I mean my like very simplistically, the carry trade, if anything at best, is simply representative of risk appetite. And when carry trades are popular and thus crowded and leveraged, it speaks to a backdrop of low volatility. You need low volatility to be able to accumulate those positions, you know, short this to buy this higher yielder. And you know, without question, as far as the butterfly flapping its wings event, the Bank of Japan allowing people to be structurally short the end for decades because of their just consistency with regards to this, you know, perma Dubvish posture. Then switching in pretty short time, arising into something more hawkish than expectations, particularly that last meeting where they you know, they raised by more than kind of market expectations. They ultimately are targeting half the bond buying, and they’d already cut off the ETF purchases. That that was absolutely not helpful for the carry trade. But for the carry trade as far as our industry goes, it is one piece of the puzzle. As far as the kajillion strategies out there, and yes, Carrie had been popular, Carrie had been crowded. To build into those trades, you need low volatility. A lot of those trades then look like trend trades. A lot of those trades are overlapping and concentric with CTAs. But it in and of itself was not the issue.
I mean my like very simplistically, the carry trade, if anything at best, is simply representative of risk appetite. And when carry trades are popular and thus crowded and leveraged, it speaks to a backdrop of low volatility. You need low volatility to be able to accumulate those positions, you know, short this to buy this higher yielder. And you know, without question, as far as the butterfly flapping its wings event, the Bank of Japan allowing people to be structurally short the end for decades because of their just consistency with regards to this, you know, perma Dubvish posture. Then switching in pretty short time, arising into something more hawkish than expectations, particularly that last meeting where they you know, they raised by more than kind of market expectations. They ultimately are targeting half the bond buying, and they’d already cut off the ETF purchases. That that was absolutely not helpful for the carry trade. But for the carry trade as far as our industry goes, it is one piece of the puzzle. As far as the kajillion strategies out there, and yes, Carrie had been popular, Carrie had been crowded. To build into those trades, you need low volatility. A lot of those trades then look like trend trades. A lot of those trades are overlapping and concentric with CTAs. But it in and of itself was not the issue.
09:20
Speaker 3
Yeah, I was gonna say, it often feels like, because we did a recent episode on the correlation trade, and we’ve talked about the low vault trade, it often feels like these are all the same trades and different the carry trade being another one, the momentum trade being another one, the same trade in different flavors.
Yeah, I was gonna say, it often feels like, because we did a recent episode on the correlation trade, and we’ve talked about the low vault trade, it often feels like these are all the same trades and different the carry trade being another one, the momentum trade being another one, the same trade in different flavors.
09:37
Speaker 2
I say this all the time. This is often used with regards to these deleveraging events. It’s oftentimes used when discussing you know, systematic strategy, you know of all events, but you know, volatility is the exposure toggle in modern market structure, and that being the case stained periods of low volatility where I would say that, you know, the big shift, the bigger shift from a macro catalyst to me that occurred over the past few weeks was back to this idea that we had been consensually and comfortably in a low Vall narrative as the market was forced into a soft landing consensus last year, right, people were, you know, perpetually trying to pull forward the hard landing recession, and end of twenty two, start of twenty three, you had the CIVB crisis that was going to be the credit crunch that pushed us over the edge, fighting fighting, fighting for the recession that never came. Ultimately, we kind of got stopped into this really comfortable backdrop soft landing fed would still be supportive. Treasury did a little work around the edges to ease financial conditions and lighten the load of the Treasury sell off and the long and rate volatility in the fall, and that low Vall backdrop was really facilitating this massive growth in the shortfall stuff that’s been out there and the AUM growth. And it’s not just shortvall premium income ETFs, of course, it’s VRP, it’s dispersion strategies, it’s you know, correlation short correlation trades, it’s qis, you know at banks, their proliferation, especially being used by multi strategy hedge funds which are big users of those products. All of that stuff created the short vall supply. And here’s kind of the kicker to me with regards to that soft landing outcome, which was consensual. We had had a kind of assigned a zero delta of a hard landing, but we had been saying for quite a long time market had been fixated this mark. This economy goes as far as the consumer goes, and the consumer is a function of the employment data. And when in you know, less than a month span, we’ve seen six of the last seven major US labor releases at magnitude downside surprises. You kind of got the whites of the eyes of this trade, where well, holy moly, like maybe that’s not a zero delta, Maybe that’s a twenty delta on the hard landing and that completely ruptures as a macro catalyst, the comfort and the delta on that short vall trade, the comfort in that soft landing trade, and that, to me, if anything, if you want to point to one thing, was what lit the match to then take advantage of the larger structural short ball supply that, like every other short ball build up in history, does have a stopping out, and that’s where we are.
I say this all the time. This is often used with regards to these deleveraging events. It’s oftentimes used when discussing you know, systematic strategy, you know of all events, but you know, volatility is the exposure toggle in modern market structure, and that being the case stained periods of low volatility where I would say that, you know, the big shift, the bigger shift from a macro catalyst to me that occurred over the past few weeks was back to this idea that we had been consensually and comfortably in a low Vall narrative as the market was forced into a soft landing consensus last year, right, people were, you know, perpetually trying to pull forward the hard landing recession, and end of twenty two, start of twenty three, you had the CIVB crisis that was going to be the credit crunch that pushed us over the edge, fighting fighting, fighting for the recession that never came. Ultimately, we kind of got stopped into this really comfortable backdrop soft landing fed would still be supportive. Treasury did a little work around the edges to ease financial conditions and lighten the load of the Treasury sell off and the long and rate volatility in the fall, and that low Vall backdrop was really facilitating this massive growth in the shortfall stuff that’s been out there and the AUM growth. And it’s not just shortvall premium income ETFs, of course, it’s VRP, it’s dispersion strategies, it’s you know, correlation short correlation trades, it’s qis, you know at banks, their proliferation, especially being used by multi strategy hedge funds which are big users of those products. All of that stuff created the short vall supply. And here’s kind of the kicker to me with regards to that soft landing outcome, which was consensual. We had had a kind of assigned a zero delta of a hard landing, but we had been saying for quite a long time market had been fixated this mark. This economy goes as far as the consumer goes, and the consumer is a function of the employment data. And when in you know, less than a month span, we’ve seen six of the last seven major US labor releases at magnitude downside surprises. You kind of got the whites of the eyes of this trade, where well, holy moly, like maybe that’s not a zero delta, Maybe that’s a twenty delta on the hard landing and that completely ruptures as a macro catalyst, the comfort and the delta on that short vall trade, the comfort in that soft landing trade, and that, to me, if anything, if you want to point to one thing, was what lit the match to then take advantage of the larger structural short ball supply that, like every other short ball build up in history, does have a stopping out, and that’s where we are.
12:47
Speaker 1
I do think it’s kind of funny that one of the things that’s happened in recent days is the yield curve has uninverted. And the yield curve, of course, was the thing that last year when everyone was focused on recession, they were so focused on the curve inversion, and now it’s like, oh, it uninverted, but actually we’re all worried about the hard landing now. Anyway, how much short vall exposure do you think is still out there? Or have the past couple of days seen a cleaning of the house, so to.
I do think it’s kind of funny that one of the things that’s happened in recent days is the yield curve has uninverted. And the yield curve, of course, was the thing that last year when everyone was focused on recession, they were so focused on the curve inversion, and now it’s like, oh, it uninverted, but actually we’re all worried about the hard landing now. Anyway, how much short vall exposure do you think is still out there? Or have the past couple of days seen a cleaning of the house, so to.
13:14
Speaker 2
Speak, so great? You know, it’s the trillion dollar question. I think a lot of folks after that Friday freakout, and this is again, this is part of the issue here. We’ve been conditioned on a multi year decade type of look back. We’ve been conditioned to see these opportunities to monetize downside hedges or say VIX upside convexity, you know, or SMP downside in this span of hours when you have these whatever the macro catalyst is, you know, we slide from dealers from a long gamma spot to a short gamma spot at trigger systematic synthetic short gamma. You get these accelerant flows and you have these wipeouts. You have like a couple of hours max. To monetize those hedges before reflexive all sellers reappear, before the dip buyers reappear. And I think the hard lesson here was due to the magnitude of how much shortfall there were across you know, multiple strategies that we referenced earlier. A lot of people ended the day Friday thinking that they could be SHORTVALL and maybe short delta, you know, short the market, but also too short ball coming out of that trade because the wall moves were so magnificent, you know, so outlier. The issue then became that they got their fingers blown off on the Monday reopen, so you know, you can lose money trying to do that based on prior back test on these VALL squeezes and these outlier ball squeezes. It’s when Asia crashed overnight, and that in and of itself is another conversation, another you know, probably a separate recording for us. But when Asia crashed overnight and those people woke up and vall was where it was, and you saw more you know, more bid for tails and vivix went absolutely bonkers.
Speak, so great? You know, it’s the trillion dollar question. I think a lot of folks after that Friday freakout, and this is again, this is part of the issue here. We’ve been conditioned on a multi year decade type of look back. We’ve been conditioned to see these opportunities to monetize downside hedges or say VIX upside convexity, you know, or SMP downside in this span of hours when you have these whatever the macro catalyst is, you know, we slide from dealers from a long gamma spot to a short gamma spot at trigger systematic synthetic short gamma. You get these accelerant flows and you have these wipeouts. You have like a couple of hours max. To monetize those hedges before reflexive all sellers reappear, before the dip buyers reappear. And I think the hard lesson here was due to the magnitude of how much shortfall there were across you know, multiple strategies that we referenced earlier. A lot of people ended the day Friday thinking that they could be SHORTVALL and maybe short delta, you know, short the market, but also too short ball coming out of that trade because the wall moves were so magnificent, you know, so outlier. The issue then became that they got their fingers blown off on the Monday reopen, so you know, you can lose money trying to do that based on prior back test on these VALL squeezes and these outlier ball squeezes. It’s when Asia crashed overnight, and that in and of itself is another conversation, another you know, probably a separate recording for us. But when Asia crashed overnight and those people woke up and vall was where it was, and you saw more you know, more bid for tails and vivix went absolutely bonkers.
15:05
Speaker 1
Oh yeah, volatility of volatility, that was yeah, you know.
Oh yeah, volatility of volatility, that was yeah, you know.
15:09
Speaker 2
As far as just a read on demand for tales, it was over for those people. So the second day in a row and now you have a pattern here where you know, for me one, shame on you, for me twice shame on me, where you’ve gotten your your fingers blown off two days in a row trying to play this trade. And by the way, this VALL squeeze, this vall out performance on a beta adjusted look was unlike anything we’d seen, I’m telling you, like past COVID extremes. At a point past vallmageddon, we’re to LTCM. You know, some of these metrics were unbelievable, whether it was VIX relative to S and P, whether it was vall of all relative to VIX, whether it was skew relative to add the money imply valves all these different metrics one hundred percentile. This was a volume. This was not a stocks event, and that occurred. You’re now dealing with an environment from a risk management perspective, and I know you just had some really good content, you know, talking about risk management on the show. From a risk management perspective, and your var that it is going to be incredibly difficult to get that you know, reflexive say systematic buyer back in the market right now, or that discretionary macro trader who who’s running the back test and the back tests are saying after these types of overreactions, you’ve got to be long the market in shortfall. But the problem is you’re blowing out your risk budget now on down days we snap back overnight in Japan, you’re blowing out your risk budget up with You’re not going to be able to allocate any risk into this trade of any size that’s going to make a difference. So we’re still on very thin ice and the market is still priced for a lot of crash.
As far as just a read on demand for tales, it was over for those people. So the second day in a row and now you have a pattern here where you know, for me one, shame on you, for me twice shame on me, where you’ve gotten your your fingers blown off two days in a row trying to play this trade. And by the way, this VALL squeeze, this vall out performance on a beta adjusted look was unlike anything we’d seen, I’m telling you, like past COVID extremes. At a point past vallmageddon, we’re to LTCM. You know, some of these metrics were unbelievable, whether it was VIX relative to S and P, whether it was vall of all relative to VIX, whether it was skew relative to add the money imply valves all these different metrics one hundred percentile. This was a volume. This was not a stocks event, and that occurred. You’re now dealing with an environment from a risk management perspective, and I know you just had some really good content, you know, talking about risk management on the show. From a risk management perspective, and your var that it is going to be incredibly difficult to get that you know, reflexive say systematic buyer back in the market right now, or that discretionary macro trader who who’s running the back test and the back tests are saying after these types of overreactions, you’ve got to be long the market in shortfall. But the problem is you’re blowing out your risk budget now on down days we snap back overnight in Japan, you’re blowing out your risk budget up with You’re not going to be able to allocate any risk into this trade of any size that’s going to make a difference. So we’re still on very thin ice and the market is still priced for a lot of crash.
16:54
Speaker 3
I’m glad you brought it back to the sort of simple macro, which is just that look, you know, suddenly people realized on Friday, maybe that soft land between Paul on Wednesday and the employment report on Friday. Maybe that soft landing scenario that everyone consensus had emerged. Maybe it’s no done deal. You said it could be a separate recording. Can you give us like the thirty second version of that Sunday night Asia crash and what you thought was going on there or what was on your mind?
I’m glad you brought it back to the sort of simple macro, which is just that look, you know, suddenly people realized on Friday, maybe that soft land between Paul on Wednesday and the employment report on Friday. Maybe that soft landing scenario that everyone consensus had emerged. Maybe it’s no done deal. You said it could be a separate recording. Can you give us like the thirty second version of that Sunday night Asia crash and what you thought was going on there or what was on your mind?
17:24
Speaker 2
Then we’ve seen so many times after a Friday sell off, Asia just act poorly, right, I mean, and I you know, I then too think back to like the financial crisis where you know, it was one large hedge fund kind of liquidating their converts book that really started like a knock on calamity leading it, you know, around the Leman event. You know, this I think too, was then further amplified. Let’s look at Japan specifically. The Japan trade has been a great trade. The long knee k the short end obviously the care component have been great trend trades with high sharps for a reason. You know, there’s a fundamental economic story this. You know, you got the third arrow achieved, You’ve got you know a wage renegotiation. Now corporates have pricing power consumers and can digest it all this stuff. They escape deflation. Great story. It was crowded and it’s illiquid, and it doesn’t trade very well. And in a world where the US exceptionalism trade is dominated for a decade, and Europe is eternally tied into China, and Europe is eternally cyclical, and they don’t buy back their stocks and they don’t have any secular growth tech and all those things, a lot of global equities managers were looking for opportunities to diversify out and play Japan. And that meant real money in Japan, and that meant hedge fund started chasing in Japan. That meant retail certainly domestically in Japan playing the stock market boom. So you just had a lot of hot money, a lot of fast money, a lot of slow money in a place that doesn’t trade very well. And when you got that first d risking, particularly amongst a lot of overseas leveraged pod multi strat investors that have been there, you shoot first, ask questions later. It’s skinny exits and the deleveraging and getting out of a place that is that type of liquid liquidity constrained. It was you know, just a magnitude’s move, but it was all the stuff that had the highest sharps. It was topics banks, right, It was all those things that are going to be most sensitive to you know, escaping negative interest rates, and you know you crowded into them and you crowd out of them. And the magnitude of those moves now as you’re seeing both down and back up, you know, speaks to how much leverage was in that trade. And that was just a particularly sloppy unwind.
Then we’ve seen so many times after a Friday sell off, Asia just act poorly, right, I mean, and I you know, I then too think back to like the financial crisis where you know, it was one large hedge fund kind of liquidating their converts book that really started like a knock on calamity leading it, you know, around the Leman event. You know, this I think too, was then further amplified. Let’s look at Japan specifically. The Japan trade has been a great trade. The long knee k the short end obviously the care component have been great trend trades with high sharps for a reason. You know, there’s a fundamental economic story this. You know, you got the third arrow achieved, You’ve got you know a wage renegotiation. Now corporates have pricing power consumers and can digest it all this stuff. They escape deflation. Great story. It was crowded and it’s illiquid, and it doesn’t trade very well. And in a world where the US exceptionalism trade is dominated for a decade, and Europe is eternally tied into China, and Europe is eternally cyclical, and they don’t buy back their stocks and they don’t have any secular growth tech and all those things, a lot of global equities managers were looking for opportunities to diversify out and play Japan. And that meant real money in Japan, and that meant hedge fund started chasing in Japan. That meant retail certainly domestically in Japan playing the stock market boom. So you just had a lot of hot money, a lot of fast money, a lot of slow money in a place that doesn’t trade very well. And when you got that first d risking, particularly amongst a lot of overseas leveraged pod multi strat investors that have been there, you shoot first, ask questions later. It’s skinny exits and the deleveraging and getting out of a place that is that type of liquid liquidity constrained. It was you know, just a magnitude’s move, but it was all the stuff that had the highest sharps. It was topics banks, right, It was all those things that are going to be most sensitive to you know, escaping negative interest rates, and you know you crowded into them and you crowd out of them. And the magnitude of those moves now as you’re seeing both down and back up, you know, speaks to how much leverage was in that trade. And that was just a particularly sloppy unwind.
19:57
Speaker 1
So, as you said, people have had their fingers burnt multiple times now and we think there might be some short vall exposure still left in the market. What are these sort of I guess either pain points that you’re looking at that would accelerate the downside or the sort of things you need for a durable recovery. As you said, I guess it’s going to take some time for those like windows of volatility events and the var spikes to fade into the distance. But is there anything there that you’re watching?
So, as you said, people have had their fingers burnt multiple times now and we think there might be some short vall exposure still left in the market. What are these sort of I guess either pain points that you’re looking at that would accelerate the downside or the sort of things you need for a durable recovery. As you said, I guess it’s going to take some time for those like windows of volatility events and the var spikes to fade into the distance. But is there anything there that you’re watching?
20:28
Speaker 2
So the thing to me where I was still uncomfortable, for instance, in the micro term about you coming into today and how if we’d be able to hold onto the rally last night was at the end of the US cash equity session yesterday, it was an ugly close from a ball perspective, Vall went out bid, skewing out bid Vallavall was super firm, super sticky. There was no pullback despite you know, for instance, in the last couple minutes of the day, there was a large hedge online, large put spread on line that bought you know, just about four and a half billion bucks of Delta in a rally, it’s like twenty handles. But like VALL was still stressy. That to me is indicative of the fact that they’re still and I think it’s a dealer problem. I think it’s a market maker problem that there is still a lot of embedded kind of short gamma in the VIX complex and there still is a lot of short skew out there maybe in like the dealer the S and P positioning and that VIX complex is really interesting, guys, because I feel like maybe we talked about this when I was on the show once before, but on a kind of pre Dodd Frank view versus where we are now from speaking with VIX dealers VIX options dealers around the street, you maybe have ten percent twenty percent max of the risk taking capacity that you used to have. But as the equity market rally became so unstable over the course of the past year, VIX upsides. So VIX calls was or you know, all spreads. But that’s not a true hedge. That’s a separate conversation where it’s kind of the most popular tail hedge out there. You know, VIX is inherently convexed. It’s a square root of variance, so it’s going to move off the line, it’s going to outperform and do you know, kind of a crashy type situation. There was a massive amount of short VIX calls for dealers over the course of the past year. We’ve had a couple events, we get squeezy and then it you know, fills back in. People keep reloading on it because this trade has been quite cheap. Once this short vall trade really began to implode, what you started seeing and we did recently have another reload last week of dealer of a dealer getting short you know, really big size and VIX calls. When VVIX starts expanding like that, you know, that they are stressed and scrambling to cover what is effectively their short gamma, and they have to go out and they have to buy VIX delta, which is buying VIX futures, or they have to go out in this case because we’re now negative spot vault correlation, I meaning as the market’s going lower of all is going higher again, they have to go out in short futures. So that to me, when we saw the market staying stressing into the clothes, I know that people are still you know, buried in some of those trades and are not out. I think a lot of people were finally getting the shoulder tap in the last you know, thirty minutes yesterday saying this hasn’t pulled back. We haven’t been able to cover this. We got to cover and cover out some of this risk. So that to me was indicative on the go forward to the point that you raised with regards to when do things stabilize. I want to see this current flow which is just hedge unwined hedge monetization, which is going to help stabilize the market in periods. I want to see that turn more into a willingness for the ball sellers to reemerge out of their bunkers. That’s a big if, right now, right are you able to be short vall? Are you able to be short gamma? Are you able to be short skew or you be able to short crash, you know, systematically in light of the ball events of the last few days and whether or not you can get approval or the risk budget to put that trade on. But there still has been massive asset growth across the VRP complex, across the premium income ets, across the dispersion books, across QIS. Products that are exploiting zero DTE options, no overnight risk, Those still have to trade, those still have to sell all, those still have to short VEGA. And I think that they are going to slowly reappair. And as they begin to slowly reappear, and that’s going to take time, dealers start getting longer gamma again. Range compression begins to set back in trailing realized VALL windows begin to roll back over ever so incrementally. But the trick is this VALL control, which is kind of a euphemism, a generic for anything from target volatility funds to various annuities. To assume of these balanced funds that shift out of equities into cash or during of all event, well, we view them as the primary source of much of this deleveraging over the last week again volatilities or exposure toggle, we got it. We think they’ve sold almost over the past two weeks one hundred and thirty billion bucks of equities because of that realized VALL issue that we’re talking about, where you know, still with the front Vick’s future right now. As I was walking in here was kind of you know, twenty eight or so, you’re still you know, pricing in something close to one point eight percent daily moves in the S and P. You know, it’s going to take a month of fifty basis point moves to get half of that buying back. Even just two weeks of fifty BIPs moves a day, which is a magnitude smaller versus where we are right now and we’re still priced for stress, is barely going to create any buying right now. So you need a sustained period of calm. You don’t need rallies, you just need you know, VALL tends to mean revert at some point. You’ve got to keep feeding volatility with big moves or else it tends to mean revert lower, and that’s when the ball sellers reappear, and that’s when dealers get long gamma, and that’s when markets begin to compress again, and that’s when you know, we can see some kind of resumption of, say, more constructive behavior.
So the thing to me where I was still uncomfortable, for instance, in the micro term about you coming into today and how if we’d be able to hold onto the rally last night was at the end of the US cash equity session yesterday, it was an ugly close from a ball perspective, Vall went out bid, skewing out bid Vallavall was super firm, super sticky. There was no pullback despite you know, for instance, in the last couple minutes of the day, there was a large hedge online, large put spread on line that bought you know, just about four and a half billion bucks of Delta in a rally, it’s like twenty handles. But like VALL was still stressy. That to me is indicative of the fact that they’re still and I think it’s a dealer problem. I think it’s a market maker problem that there is still a lot of embedded kind of short gamma in the VIX complex and there still is a lot of short skew out there maybe in like the dealer the S and P positioning and that VIX complex is really interesting, guys, because I feel like maybe we talked about this when I was on the show once before, but on a kind of pre Dodd Frank view versus where we are now from speaking with VIX dealers VIX options dealers around the street, you maybe have ten percent twenty percent max of the risk taking capacity that you used to have. But as the equity market rally became so unstable over the course of the past year, VIX upsides. So VIX calls was or you know, all spreads. But that’s not a true hedge. That’s a separate conversation where it’s kind of the most popular tail hedge out there. You know, VIX is inherently convexed. It’s a square root of variance, so it’s going to move off the line, it’s going to outperform and do you know, kind of a crashy type situation. There was a massive amount of short VIX calls for dealers over the course of the past year. We’ve had a couple events, we get squeezy and then it you know, fills back in. People keep reloading on it because this trade has been quite cheap. Once this short vall trade really began to implode, what you started seeing and we did recently have another reload last week of dealer of a dealer getting short you know, really big size and VIX calls. When VVIX starts expanding like that, you know, that they are stressed and scrambling to cover what is effectively their short gamma, and they have to go out and they have to buy VIX delta, which is buying VIX futures, or they have to go out in this case because we’re now negative spot vault correlation, I meaning as the market’s going lower of all is going higher again, they have to go out in short futures. So that to me, when we saw the market staying stressing into the clothes, I know that people are still you know, buried in some of those trades and are not out. I think a lot of people were finally getting the shoulder tap in the last you know, thirty minutes yesterday saying this hasn’t pulled back. We haven’t been able to cover this. We got to cover and cover out some of this risk. So that to me was indicative on the go forward to the point that you raised with regards to when do things stabilize. I want to see this current flow which is just hedge unwined hedge monetization, which is going to help stabilize the market in periods. I want to see that turn more into a willingness for the ball sellers to reemerge out of their bunkers. That’s a big if, right now, right are you able to be short vall? Are you able to be short gamma? Are you able to be short skew or you be able to short crash, you know, systematically in light of the ball events of the last few days and whether or not you can get approval or the risk budget to put that trade on. But there still has been massive asset growth across the VRP complex, across the premium income ets, across the dispersion books, across QIS. Products that are exploiting zero DTE options, no overnight risk, Those still have to trade, those still have to sell all, those still have to short VEGA. And I think that they are going to slowly reappair. And as they begin to slowly reappear, and that’s going to take time, dealers start getting longer gamma again. Range compression begins to set back in trailing realized VALL windows begin to roll back over ever so incrementally. But the trick is this VALL control, which is kind of a euphemism, a generic for anything from target volatility funds to various annuities. To assume of these balanced funds that shift out of equities into cash or during of all event, well, we view them as the primary source of much of this deleveraging over the last week again volatilities or exposure toggle, we got it. We think they’ve sold almost over the past two weeks one hundred and thirty billion bucks of equities because of that realized VALL issue that we’re talking about, where you know, still with the front Vick’s future right now. As I was walking in here was kind of you know, twenty eight or so, you’re still you know, pricing in something close to one point eight percent daily moves in the S and P. You know, it’s going to take a month of fifty basis point moves to get half of that buying back. Even just two weeks of fifty BIPs moves a day, which is a magnitude smaller versus where we are right now and we’re still priced for stress, is barely going to create any buying right now. So you need a sustained period of calm. You don’t need rallies, you just need you know, VALL tends to mean revert at some point. You’ve got to keep feeding volatility with big moves or else it tends to mean revert lower, and that’s when the ball sellers reappear, and that’s when dealers get long gamma, and that’s when markets begin to compress again, and that’s when you know, we can see some kind of resumption of, say, more constructive behavior.
26:15
Speaker 1
Joe, you know what’s cool. On the terminal, you can chart target VALL equity exposure and you can see it peeking in sort of June and then obviously falling very precipitously in recent days. So that’s kind of cool. Charlie. We have to keep this fairly short because it’s an emergency episode. We want to get it out quickly. But I have one very important question for you, which is I have someone visiting me in the next week or so in New York. Where should I take them for steak? Oh?
Joe, you know what’s cool. On the terminal, you can chart target VALL equity exposure and you can see it peeking in sort of June and then obviously falling very precipitously in recent days. So that’s kind of cool. Charlie. We have to keep this fairly short because it’s an emergency episode. We want to get it out quickly. But I have one very important question for you, which is I have someone visiting me in the next week or so in New York. Where should I take them for steak? Oh?
26:43
Speaker 2
Good question.
Good question.
26:44
Speaker 1
I figure you’re the guy to ask. We ask you about VALL and meet basically.
I figure you’re the guy to ask. We ask you about VALL and meet basically.
26:49
Speaker 2
You know it’s so funny is that I get, you know, I’m a home steak guy, like I have a half cow share, so I get, you know, these parts delivered to me from up think Tracy would have.
You know it’s so funny is that I get, you know, I’m a home steak guy, like I have a half cow share, so I get, you know, these parts delivered to me from up think Tracy would have.
27:01
Speaker 1
Yeah, I love bone marrow. I have.
Yeah, I love bone marrow. I have.
27:05
Speaker 2
The bone marrow on the steak then, right.
The bone marrow on the steak then, right.
27:08
Speaker 1
It’s like eating a life force.
It’s like eating a life force.
27:10
Speaker 2
I drink at the bone, broth, all that stuff. So I honestly am somewhat averse to restaurant steakhouses, oftentimes cooking with vegetable oil, siedos, all that stuff. I’ve always been like a big, brawny New York City steakhouse type of a guy, So like a very generic smith and wooly type of a Yeah, lunch.
I drink at the bone, broth, all that stuff. So I honestly am somewhat averse to restaurant steakhouses, oftentimes cooking with vegetable oil, siedos, all that stuff. I’ve always been like a big, brawny New York City steakhouse type of a guy, So like a very generic smith and wooly type of a Yeah, lunch.
27:35
Speaker 1
Yeah, actually, I’d be totally Actually.
Yeah, actually, I’d be totally Actually.
27:37
Speaker 3
My lunch plans just fell through, so I actually have some time. We could talk through some stuff. Let’s good steak for lunch.
My lunch plans just fell through, so I actually have some time. We could talk through some stuff. Let’s good steak for lunch.
27:42
Speaker 1
Yeah, let’s do that, okay.
Yeah, let’s do that, okay.
27:48
Speaker 3
Lots More is produced by Carmen Rodriguez and dash Ol Bennett, with help from Moses on Them and Kill Brooks.
Lots More is produced by Carmen Rodriguez and dash Ol Bennett, with help from Moses on Them and Kill Brooks.
27:54
Speaker 1
Our sound engineer is Blake Maples. Sage Bowman is the head of Bloomberg Podcasts.
Our sound engineer is Blake Maples. Sage Bowman is the head of Bloomberg Podcasts.
27:59
Speaker 3
Please rate you and subscribe to Odd, Lots and Lots More on your favorite podcast platforms.
Please rate you and subscribe to Odd, Lots and Lots More on your favorite podcast platforms.
28:05
Speaker 1
And remember that Bloomberg subscribers can listen to all our podcasts ad free by connecting through Apple Podcasts. Thanks for listening.
