Monday November 7

Markets rallied today as it seems that investors priced down some of the political risk. The S&P 500 rose 2.2% to 2,131 and the Dow Jones rose 2.1% to 18,259. The VIX fell nearly 18% to 18.53 indicating a decrease in risk aversion in equity markets. Over the weekend the FBI issued a statement that said that the new Clinton emails they were investigating didn’t contain any material new information. As a result it could be perceived that her odds to win the election are rising as opposed to last week when that uncertainty led to heightened risk aversion. On that backdrop rates sold off. The 2 year yield rose 3bp to 0.82% and the ten year yield added 5bp to 1.83%. Accordingly 2yr vs 10yr bear steepened 2bp to 1.01%. The US dollar similarly also had a strong day against all peers except the Mexican peso. USD fell more than 2% against MXN to P$18.6384 seeming to price down less of a chance of Trump winning the election. USD gained 0.9% against EUR to $1.1043. USD rose 1.3% against JPY to Y104.5. USD rose 1% against GBP to $1.2398. Oil prices rebounded somewhat from lows reached last week amid high inventories and concerns about an Opec deal. WTI rose 2% to $44.97 and Brent added 1.6% to $46.32.

Volatility in fixed income markets is perceived to be low. This contrasts movements in equity markets which have sold off for nine consecutive days amid election uncertainty and at the same time the VIX has jumped. However fixed income markets don’t appear to be pricing in that same election uncertainty, and if they are it isn’t to the same degree as equity traders are. Bank of America’s MOVE index, although elevated relative to a few weeks ago, is at a low level relative to where it has traded this year. MOVE is calculated using swaption pricing and implied volatility. This could suggest that either traders don’t think a surprise outcome to the election will create volatility, or they don’t think that surprise outcome will happen. Although polls have been driving sentiment and markets to an extent, polls are oftentimes incorrect as evidenced by the Brexit outcome just a few months ago. That outcome created volatility across asset classes and drove the Treasury yield down to 1.31% for the 10 year. The low level of MOVE means that investors can buy protection against interest rate volatility for cheap. According to research from BAML it is better for investors to buy protection when it is expensive relative to when it is inexpensive. This suggests that swaption traders are good at pricing implied volatility as it relates to realized volatility.

Foreign reserves in China fell by more than expected last month and are currently at the lowest level in more than five years. FX reserves fell by $45.7bn which was the largest monthly decline since January. FX strategists indicated that the pace of the monthly decline was roughly in line with depreciation of the renminbi over that time period. This could indicate that investors both domestic and foreign are looking to take money out of the country as the economy slows.

Given the LIBOR rigging scandal a few years ago financial industry authorities are looking to create a new benchmark for interest rates. LIBOR has lost some credibility as it turned out that banks rigged the benchmark in some cases to benefit the positions of its traders. However those new methods haven’t gained much traction yet. The Fed proposed a benchmark called the Overnight Bank Funding rate however volume based on that benchmark has been low since it was launched in March. Trading volume on OBFR has fallen from more than $300bn in March to just $150bn currently. The benchmark is based on eurodollar transactions and the federal funds market. Declines in eurodollar transactions are one of the headwinds facing this index, and declines in those transactions have been driven by money market reform according to analysts. As a result international banks and investors have been using prime funds in the eurodollar market less. To reflect rising short term rates LIBOR has risen significantly whereas OBFR has not responded to this market change. The Fed has also proposed blending repo rates and has created three repo benchmarks that will be released over the next two years. BlackRock and PIMCO and other large investment managers are also forming a subcommittee to weigh in on this transition.

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Monday November 7

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