Its the Positions

The failure of Forward Guidance is starting to show in markets designed to "benefit" from it. The problem narrative goes something like this: The Fed fears market participant's actions in term structure futures markets will/could derail their growth forecasts. So the Fed leans on FG to keep the hounds at bay and create positions that confirm and adhere to their path.

Recently, players had increased exposure to the short side by way of puts and outright positions. The rally has forced covering and pitching the puts back out. The problem is FG hadn't changed throughout the process. In other words, participants are dealing with a Hobson's Choice with regard to rates. Accept the Fed's position or stay out. This is leading to a decline in market depth and resilience. As we saw last Spring (almost upon us again), the inability of structural shorts to embed in the term structure means no natural buyers on the way down.  (Remember- the "natural" position of a Eurodollar player is short. )

We see evidence that many are giving up. Market moves continue to be driven by liquidation, the unhealthiest interaction. Rather than glean insight from a free futures term structure, the Fed has cast its lot with the faux stability of FG. Ian Malcolm said it best in Jurassic Park:

The reason is that the behavior of the system is sensitively dependent on initial conditions.

Use a cannon to fire a shell of a certain weight, at a certain speed, and a certain angle of inclination-and if I then fire a second shell with almost the same weight, speed, and angle-what will happen? The two shells will land at almost the same spot - That's linear dynamics. But if I have a weather system that I start up with a certain temperature and a certain wind speed and a certain humidity-and if I then repeat it with almost the same temperature, wind, and humidity-the second system will not behave almost the same. It'll wander off and rapidly will become very different from the first. Thunderstorms instead of sunshine. That's nonlinear dynamics. They are sensitive to initial conditions: tiny differences become amplified.

All the dinosaurs are female, and all the positions are long....what could go wrong?



One thought on “Its the Positions

  1. Lawrence Martin

    Never before have so few forced financial misery on so many for so long. Your analogy about weather modeling is spot on. The further you get from t=0 the less you know about the outcome. We are living in a piecewise linear world. The piecewise part seems to be no more than 30 days at a time in econ data terms. Oh the BLS report .. reset and recalculate. In the meantime, lets zirp it.


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