Credit and volatility moves have been major themes since the October sell off. Credit went from dormant to exploding price action as people realized among other things oil related moves were impacting the credit space.
European credit, iTraxx main, is retracing today, but this space remains trading rather elevated compared to other risky assets. Given the fact most big events have ebbed out, credit is starting to look a bit rich, if nothing compared to other assets. The Brexit and Italian sagas are very much alive, but there are probably more optimal hedges here than credit protection.
We warned about equities close to bouncing as well as volatilities about to implode last week. Eurostoxx 50 volatility index, V2X, is crashing today, as the fear index moves down to more sanguine levels given global macro risks. As always, people tend to confuse pace with direction, and most investors end up buying protection at way too expensive levels. Longer term “fair” levels of V2X are around the 15 level.
Note how the SX5E index term structure has inverted again. We are now seeing the normal inverted curve (orange), opposed to what we saw when SX5E traded at the 3150 level (green). Expect more puking of volatility as investors once again mispriced risk and the cost of hedging.
Eurostoxx 50 futures, VG1, (orange) versus iTraxx (white, inverted). Note how credit was showing relatively little stress during the first week of November. This then reversed abruptly, credit exploded higher and remains rich compared to equities here. For the mean reversion global macro player, it could be interesting looking at the credit versus equity trade here.
Below chart shows the iTraXX (white) versus V2X (orange). Volatility and credit both have the hedge component as instruments, although they are different. They both price risk, although slightly differently. The gap between the two remains relatively wide.
The equity rally and the volatility implosion today doesn´t change the fundamental picture of the world, but it sure does affect aggregate p/l, and is according to us, further frustrating the crowds. In terms of extreme greed and fear, often the most interesting trading set ups arise. We are watching those closely, so stay tuned!
Source: charts by Bloomberg