When There’s No Liquidity, It’s Best To Stay On The Sidelines

One of the perils of macro trading is that markets move 24 hours a day, and newsworthy events are not confined to the normal trading day in any particular time zone. When market-moving events occur in the middle of the night, one occasionally (or, depending on one’s proclivities, nightly) receives a phone call to say that something’s going on. Macro Man generally tries to manage his book in a way that minimizes the need for late night phone calls and trading, but on occasion such outcomes are unavoidable.

Such was the case last night, when Ben Bernanke brought his own version of Hammer time to financial markets. The impact was instantaneous, especially in fixed income, with both directional and RV strategies gapping on virtually no liquidity. Such environments are not exactly conducive to going quickly back to sleep, and in retrospect Macro Man feels like a rabbit caught in the headlights, with a case of red eye to boot.

There’s not much you can do except sell what you can - a strategy apparently pursued by more (and bigger) punters than Macro Man. As noted yesterday, the moves in some of these short-term interest rate contracts are historic, and has led to such perverse situations as the following:

*Between Thursday’s close and Monday’s close, December short sterling fell 34 bps

* Between Thursday’s close and Monday’s close, 94.50 calls on that Dec short sterling calls were unchanged in value.

Ay caramba! The rise in implied vol completely offset the delta loss of the option. That, Macro Man would suggest, is a market that is close to ungameable.

And that, ultimately, is a decision that each of us have to make. What is cheaper: the opportunity cost of missing a “lay up” trade at current levels, or the actual cost of putting on the lay up trade, misjudging your market liquidity, and losing more money than you thought possible?

Given that Macro Man already accomplished the latter on certain positions this week (thankfully, at least partially offset by other, more successful trades) , he’s happy to opt for the former.

And make no mistake- market pricing is currently pretty aggressive. The market is now pricing in more than 2 Fed rate hikes by the end of the year; this time last week, 14 bps were priced. The one week shift in the Fed funds curve, pictured below, has been substantial.

Somewhat amusingly, Macro Man’s good buddies the Russkies have chosen this moment of maximum market distress/minimum market risk appetite to finally allow the rouble to strengthen. In what appears to be a reval of the currency, the RUB has broken through the erstwhile support of its 55c US/ 45c EUR basket.

These markets are hard enough as it is. But when the world’s third largest holder of FX reserves is actively trying to screw you over, Macro Man has to believe that he’s not the only macro man suffering from a bit of red eye this morning

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