In Europe everything seems to be fine, despite the recent imploding PMIs and other “local” problems such as the Brexit etc. We won’t go into details, but recent IFO is another bad to add to the not overly great economy in Europe, but as we all know, markets trade on narratives.

More importantly than the economy itself is how markets price risk. It was only a month ago when markets were in turmoil, volatilities exploded to the upside, credit protection was scarce and investors acting in total panic. Back then we suggested capitulation signs were flashing and we argued for the reverse about to happen, i.e. a bounce and calmer volatilities.

Practically, all panics have the same ingredients, investors lose their heads, overpay for protection as they confuse speed with direction. The reverse then eventually happens, with all hedges reversing, and many times go from one extreme to the other. Since the Christmas turmoil, the only thing that has happened is the narrative has changed, but the “fundamentals” remain the same.

If we saw panic back then, we are now starting to reach the inverse panic, especially in Europe.

Credit, iTraxx main, has come off hard since the panic levels a month ago. Credit is at levels last seen in November 2018.

Eurostoxx 50 vol, V2X, has collapsed from 25 to 14.8 in a month. European volatility has been less volatile than the VIX, but note the V2X is now approaching the “natural max low” area. Volatility is mean reverting and tends to overshoot both ways.

None of the DM equity markets have moved much this week, and as a consequence volatility has come off. Note the SX5E implied volatility (blue) versus realized volatilities (10, 30, 60 days).

Eurostoxx 50 term structure has come in massively compared to a month ago. Green is how the vol curve traded a month ago, and orange is how we trade today. The entire vol curve is down, but even more notable is the shift lower in short term maturities.

Long options trades for speculation or hedging are becoming interesting again. Stay tuned!

Source: charts by Bloomberg