The VIX – Too Quiet?

The financial media’s approach to the fiscal cliff story was about as subtle as a herd of elephants. Every day we were bashed over the head with the dire consequences that would befall our nation the very moment we hit January 1st. Never mind that it wasn’t true – it made a good story, and doomsaying is tried and true method of boosting ratings.

But for all the media’s efforts, the “market” was about as scared as Felix Baumgartner is of heights… not very.  In the days before the deal was finally reached, we saw a modest spike in the CBOE’s volatility index – the VIX, but overall the amount of fear as measured by the so called “fear index” was essentially nonexistent.

With the fiscal cliff in the rear view mirror, we’re now approaching the debt ceiling – and this time around an apocalyptic hysteria might actually be justified. Unlike the fiscal cliff, any debt ceiling shenanigans which result in the US not paying some of its debts on time could have immediate impact.  Casting doubt on the reliability of US debt is not something easily erased, and there are far more ways this legislative showdown could go wrong than go right.

And how has the VIX responded to this possibility?  It’s about as scared Baumgartner on the Dumbo ride at Disney, dropping to its lowest level since June 2007.

Disclaimer: past performance is not necessarily indicative of future results.

So what’s going on? How can the VIX be so low when there’s so much that could still go wrong? Is everyone really convinced that Congress is going to behave like adults and solve this before we’ve irreparably damaged the United States’ credibility? Do they think that the Obama administration is bluffing about their unwillingness to use the 14th amendment or the trillion dollar coin to avert disaster at the last minute? Is this a case of partying until the lights go out?

Or, have we just been “crisised” out? There are still several weeks left for the financial media to get their hysteria machine up and running, and for the VIX to increase to levels that make more sense in the shadow of such a crisis.

All we know is that volatility expansion tends to come out of periods of low volatility like we’re seeing now – a sort of calm before the storm; so the lower it goes and the more people ignore looming crises, so much the better for long volatility loving managed futures which should benefit from its eventual move higher. Of course, sooner rather than later would sure be nice.

The Fiscal Swerve?

Leading up to New Year’s Eve, there was much ado about nothing the January 1st deadline for striking a deal on the fiscal cliff. Congress, dysfunctional and frequently misguided though they are, knew better. Yes, the economic consequences were going to be dire in the long run had a deal not been hammered out, but to hear the media talk about it, one would have thought that U.S. GDP would have been immediately decimated. In reality, the projections being passed around as disaster porn would have played out over the course of a year or longer, and Congress knew it. No, January 1st didn’t matter, and neither did those projections. Congress just needed to pass a deal prior to the markets opening today in order to prevent a -3% or greater risk off drop that would have backed them into a corner where political capital losses would have been even more steep. Fortunately for them, as the Washington Post reports, a deal was finally struck in the 11th hour:

Congress approved a plan to end Washington’s long drama over the “fiscal cliff” late Tuesday after House Republicans surrendered to President Obama’s demand to let taxes rise on the nation’s richest households.

The House voted 257 to 167 to send the measure to Obama for his signature; the vote came less than 24 hours after the Senate overwhelmingly approved the legislation.

Good news to be sure, and the markets are breathing a sigh of relief:

Source: Disclaimer: past performance is not necessarily indicative of future results.

So what did this magical deal look like?  The Washington Post continued (emphasis ours):

The bill will indeed shield millions of middle-class taxpayers from tax increases set to take effect this month. But it also will let rates rise on wages and investment profits for households pulling in more than $450,000 a year, marking the first time in more than two decades that a broad tax increase has been approved with GOP support.

The measure also will keep benefits flowing to 2 million unemployed workers on the verge of losing their federal checks. And it will delay for two months automatic cuts to the Pentagon and other agencies that had been set to take effect Wednesday.

In other words, the bill was, in many ways, a cop-out. Decisions were not made on the bigger issues; they were deferred. Discontent on the hill over the way negotiations played out is incredibly high. While the 113th Congress will tackle the delayed issues, much of the Congressional leadership will remain in place, and they’re in no mood to play nice. As Politico reported:

House Speaker John Boehner couldn’t hold back when he spotted Senate Majority Leader Harry Reid in the White House lobby last Friday.

It was only a few days before the nation would go over the fiscal cliff, no bipartisan agreement was in sight, and Reid had just publicly accused Boehner of running a “dictatorship” in the House and caring more about holding onto his gavel than striking a deal.

“Go f— yourself,” Boehner sniped as he pointed his finger at Reid, according to multiple sources present.

Reid, a bit startled, replied: “What are you talking about?”

Boehner repeated: “Go f— yourself.”

The harsh exchange just a few steps from the Oval Office — which Boehner later bragged about to fellow Republicans — was only one episode in nearly two months of high-stakes negotiations laced with distrust, miscommunication, false starts and yelling matches as Washington struggled to ward off $500 billion in tax hikes and spending cuts.

Happy new year? We’ll have to wait and see. Hopefully tempers won’t be running so high a month or so from now… or we could be back in the exact same spot.

Ten, Nine, Eight, Seven…

President Obama took to the podium today to discuss the status of Congress’ efforts to avert the self-created crisis known as the fiscal cliff. Unsurprisingly, he confirmed that there will be no grand bargain – that is, they aren’t going to attempt to deal with either long term spending or the debt ceiling in this package. Far from being the last installment of Congressional gridlock over a manufactured crisis, it seems almost certain now that we’re going to be rerunning this drama again in the coming years (especially if the polarization of Congress continues as it has recently).

But Obama did sound positive that a deal on taxes had been reached to let rates rise for higher-income Americans while keeping them flat for everyone else (in turn sending stocks higher and bonds lower) After Boehner made it clear that the Republicans would accept an increase in the tax rate, it essentially became a question not of if, but of how much. Business Insider has a breakdown on how that tax deal is shaping up.

The sequestration still needs to be taken care of, and on this Obama implied that there’s still a fair bit of work to be done. Deciding what to cut and how much was always going to be tough – few things enrage voters as much as seeing their favorite social programs slashed. But it appears that, with no more time to kick the can down the road, the threat of the cliff has finally elicited some action from Congress. Perhaps we’ll find out exactly what that means before the night is over.

Tonight when revelers are counting down from ten, it might not be a part of their New Year festivities – they may be counting the seconds until Congress finalizes the details of the fiscal cliff deal.

The real question for managed futures is what happens when the hangover cures and markets get back to business on Jan 2nd. A failure to reach a deal and big sell off would be just what the doctor ordered for the asset class, which will put in its third losing year in the past 4 after closing out 2012 today. Here’s to better times (for managed futures) ahead.

Careening Over the Dairy Cliff

In case all that fear mongering and minute-by-by minute obsessing over the fiscal cliff hasn’t sated your desire for hyperbole and manufactured crisis, you’ll be happy to know that the “cliff” meme is spilling over into other areas, too. The Congressional gridlock we all know and love has prevented our legislators from addressing the expiring farm bill, which could be seriously bad news for any dairy fans out there. Via CNN Money:

Problem is, the current bill expired last summer, and Congress had been unable to agree on a new one. Several protections for farmers have already expired, and several more are set to do so over the next few months. One of them is the dairy subsidy, which expires January 1.

But instead of leaving farmers entirely out in the cold, the law states that if a new bill isn’t passed or the current one extended, the formula for calculating the price the government pays for dairy products reverts back to a 1949 statute. Under that formula, the government would be forced to buy milk at twice today’s price — driving up the cost for everyone.

Milk futures are bought and sold both electronically and in the pits, although they tend to be very thinly traded. So far in December the average daily volume for the front month class III milk contract has been under 300 and the average daily open interest just over 3000. That’s less than a rounding error compared to the heavily traded S&P 500 e-mini contract, which has consistently had around 2.5 million in volume and open interest during the same period. Even so, the handful of milk traders out there don’t seem to be too worried about this particular cliff:

Disclaimer: past performance is not necessarily indicative of future results.

Considering that the dairy cliff would be incredibly expensive for the US government, for US citizens, and even has the dairy industry worried (since it would almost certainly reduce milk consumption), this seems like a no-brainer. Call us hopeless optimists, but this looks like one item that even the US Congress ought to be able to deal with…

P.S. If you’re wondering why the chart for milk futures is in the $17-$19 range, it’s because each contract represents 200,000 pounds of milk, and each $0.01 tick represents $20.

Managed Futures and the Fiscal Cliff

As the 24-hour news cycle finishes squeezing the last drops of interest from the election, the next “big story” was determined long ago: the fiscal cliff. It’s hard to read anything on the financial web without at least seeing a passing mention, if not a series of articles dedicated to the looming budget debate it represents. And we’re still 46 days away from the end of the year.

But in our corner of the financial world, the fiscal cliff holds a somewhat different meaning. Managed futures, as we often say, doesn’t care whether the markets are moving up or down – it’s the character of the move that determines whether CTAs prosper or muddle through. So regardless of whether we see a “grand compromise,” a temporary stopgap, or go past the deadline with no deal struck, managed futures may reap the benefits… or suffer the consequences.

Specifically, for the trend followers that make up the bulk of the industry (and who have been struggling lately), the worse-case scenario would be any outcome that leads to a short trend followed by a quick reversal. For example, if the deadline passes with no deal and all sorts of risk on markets take a dive, only to be resuscitated by a 13th-hour compromise that sends those markets shooting back into the green, trend followers could get caught in the whipsaw for losses.

However, if a deal passes over the next few weeks and the market loves it (or hates it), leading to a prolonged rise (or fall) in risk on/risk off markets… trend followers could get just the market conditions they’ve been wishing for.

Like everyone else, there’s little we can do other than anxiously watch events unfold. But unlike the “buy, hold, and hope” crowd, we at least feel a little better knowing that it isn’t a binary event for managed futures – who don’t need a resolution and higher stock market prices to succeed. And speaking of those buy and hold types, if you haven’t prepared your portfolio for the possibility of losses due to the fiscal cliff, don’t come complaining. This crisis has been about as high speed as the  Euro area problems were, meaning you’ve only had 6-12 months to prepare.