This morning, an economist from Nomura on CNBC’s Worldwide Exchange made several very good points on the state of the economy. Then she said this, “The VIX shows, against virtually any other measure, that financial market volatility causes economic retrenchment.” I understood where she was going but an hour of work with Hooper didn’t yield the same conclusion. Keith McCullough, of Hedgeye Risk Management says, “Government intervention 1) shortens economic cycles 2) increases volatility.” Again, a pertinent point well worth looking into.
My experience in the market has led me to a slightly different take. Stability, or more accurately, policy enhanced spread compression, causes economic disruption. From Fannie and Freddie to peripheral Europe, the problem is the ability of lesser credits to borrow at narrow spreads to benchmarks. A huge amount of government intervention and policy is oriented toward the false stability of spread compression. The history of the Greenspan Fed is a road map of the dangers of the artificial socialization of credit. The problem with Greece (and now Italy and Spain) is not that their borrowing cost is wide to Germany, its that they were permitted to borrow so much as if they were the same.
The economy stumbled in early Spring and Treasury yields moved down. The VIX did not break out to the upside until August contingent with equity index declines. Swaps, TEDs and other spread metrics had moved out well in advance. A bumpy ride to nowhere since has seen the VIX remain elevated, yet economic activity appears to have held on at a moderate pace. Put simply, the benchmark for financial market volatility is a lagging indicator at best. “Volatile” is the natural order of markets, “stability” is a false god and terrible metric of reality.
Eurodollars (full disclosure, I grew up with the product) and packages of futures contracts offer a unique look at the mayhem. Settled to the rate formerly known as LIBOR, most would contend they are “cheap” at the present 99.40 ish prices and the set at 40bp. I believe LIBOR and Eurodollars are attempting to reflect a new (actually original) structure that more distinctly shows their difference to Treasuries. An entire generation of traders and quants have come of age under the false constant of FF + 14bp = LIBOR. I don’t worry about a credit world that distinguishes between borrowers and counter-parties. I worry about what happens when policy and players treat all credits the same.