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Approaching a Day of Reckoning?


We may be fast approaching an inflection point, a day of reckoning depending on what factors have been driving rates higher.

"And that' why Myron Scholes
Gets chauffeured in a rolls
And Bobby Merton ain't hurtin', cherie
Cause they know how to use that
Volatility "
--Jeff Stambo

Today I heard a money manager on the financial news say the recent volatility is unprecedented. It is not. Like Bette Davis, all I can say is "Buckle up, it's going to be a bumpy ride."

Some financial pundits have been proclaiming that the recent rise in interest rates is nothing to worry about, that it is just mechanical.


Mechanics don't exist in a hologram. Somewhere in this vacuum where market victims are trapped in a world view that utterly fails to jibe with reality, dots actually get connected. Perhaps they don't get connected completely as to cause and effect, but at least there is some kind of casual linkage at the edges. You know like the inbreeding hatched by married cousins. It doesn't make sense but you understand where things went wrong.

Mechanics aren't an explanation, any more than the chicken and the egg riddle passes for Darwin's Theory of Evolution.

No, interest rates began to move up for a reason (or reasons), a reason worth exploring. While mechanics may have contributed to the dramatic rate of change, it's not the whole story.

The bulls' self-serving sublime proclamation that the marketplace will get used to higher rates flies in the face of one of the key underpinnings of the year long rally---the thesis that at the end of the day, the Fed would be lowering rates. It's a long day. It's been a day that the cheerleaders have seen postponed for at least six months. And they say the market discounts six months forward.

So, we may be fast approaching an inflection point, a day of reckoning depending on what factors have been driving rates higher.

1) Rates may have ratcheted up due expectations of stronger growth, for GDP to move from 0.6% to between 3 and 4%. Spinning the growth case may backstop the bulls.

2) Rates have been moving up on inflation fears.

3) Rates may be moving up as foreigners reduce exposure to the U.S. Treasury market.

4) Risk is being priced into the market (for whatever reason or catalyst) as participants pare down exposure to all asset classes.

If the last factor is the ruling reason, then the important thing to understand is that money will flow out of dollar denominated assets despite higher rates which normally would be supportive of the dollar.

In other words, a litmus test of the appetite for risk and the water level of liquidity may live on the tip of the tongue of the yield/dollar correlation.

The long and short of it is that rising yields and rising volatility are repricing risk. Whichever came first, as traders, we are not required to know. We are only required to recognize that it is occurring.

In my opinion, June's volatility is a shot over the bow, the tip of the ice berg for the volatility which looks to rearrange the deck chairs on the USS Complacency.
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