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Trader: “It’s Time To Take A Long, Hard Look At The Risk Scenarios”

Courtesy of ZeroHedge. View original post here.

Authored by Garfield Reynolds, a Markets Live blogger for Bloomberg.

Recent events show tail risk outcomes are being chronically underpriced by a market that’s been conditioned by a decade of QE and record-low central bank rates. Consider some of the events that have roiled markets over the past couple of weeks:

  • Italy’s populists managed to stun markets with their policies more than two months after the election. They are now close to finally taking office
  • Erdogan’s determination to use his own, contrarian, monetary policy playbook
  • The summit between the mercurial leaders of the U.S. and North Korea was canned, for now
  • Fresh outbreaks in trade tensions surrounding China and Nafta
  • Argentina seeking an IMF bailout

None of the above were unforeseen.

Sure, the timing was uncertain, but these were all obvious and apparent risks; the severe swings that followed indicate too many got caught out.

Even Malaysia’s election, a real surprise that very few saw coming, should have found markets better prepared; 1MDB’s day of reckoning had long been delayed but it had to happen at some stage. Too many interpreted the boost to Malaysia assets from crude’s rally as an endorsement of the Najib regime’s long-term viability.

The standout "shock" has been the slumps in EM assets, from FX to bonds and equities, hurt by a range of idiosyncratic factors but also by higher U.S. yields and Trump’s trade stance; both very much known knowns.

Surprisingly, even after a tumultuous May – spurred in no small part by policy and staffing uncertainties emanating from the White House – volatility gauges outside of EM FX continue to subside.

Despite prospects that mid-term U.S. elections will intensify political risks, the VIX keeps falling. True, the November contract is above front-dated, but that’s because the latter has dropped so much since its Feb. peak. There’s little sign of expectations for any October or November surprises.

Bond market indicators paint a similar picture, with the spread between current and 6-month gauges right in line with the five-year average.

It might be time to take a long, hard look at the risk scenarios. One sign that at least some investors are doing so is the sudden surge of flows into VIX ETFs.


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