Diary of a Financier

POMO, LTRO, SPX & Volatility: What They Say about the Road Ahead

In Capital Markets on Mon 27 Feb 2012 at 18:40

I found some interesting notes to record as I sifted through the markets today, so I wanted to enter them here this evening.

First, recall this tidbit from Tom McClellan I recently posted in my Bookshelf’s Top Newsstuffs. Mr. McClellan explores the Fed’s effect on markets via its Permanent Open Market Operations (POMO). As I paraphrased, he finds:

‘Fed POMOs… correlate exactly with SPX performance. POMO purchase/sale schedules are released a month in advance and suggest a market swoon until net purchases [begin] again Feb 28.’

With $4.25-5B worth of POMO net purchases settling each Tuesday and Wednesday, followed by $1.5-2B on Thursday, we’ve reached a few days worth of stimulative exercises from the Fed.

Next, the ECB will host its second LTRO on Wednesday. This is banking’s edition of cash-for-clunkers, expected to create anywhere between €200B-€1T in liquidity off of posted collateral. With even shadow banking entities planning to participate (like vendor financing automakers), I’m hoping subscriptions exceed that €200B lower bound, which would displace the net burn from Greece’s PSI haircuts. Yet, I believe the LTRO has been discounted by markets–far more than the other interventions discussed herein. This baked-in market expectation raises the bogey to €500B-600B. Anything less (or more) risks sending the wrong signals.

I’ve made my expectations clear, regarding the outlook from March:

I expect a risk-market hiccup as we enter the last week of February/first week of March. To wit, I chimed in with an important note on StockTwits last night:

Considering selling into strength this wk: #POMO net selling thru 2/28 & Greek bailout not til 3/20, net deflation now. http://t.co/3nfIfXbv

Thereafter, an earnest market correction shouldn’t arise until the first utterance of 1q2012 micro & macro data. Alcoa (AA) kicks-off everything with its earnings release around April 10. By that time, inventories should have just begun their decline from highs, about a month in advance of unemployment numbers rearing their first uptick of the year.

Looking at the weeks ahead, I’m concerned with the logistical gap between Greece’s PSI haircut (a deflationary event) and their alleged second round of Troika bailout funds (a reflationary event). I call it a “logistical gap” because the PSI debt swap is currently underway, but the bailout funds won’t be disbursed until March 20, after vigorous opposition. Through the Ides of March, the global system will have to operate less the ~€100B being wiped out by Greece’s debt swap, until (if) the €130B Troika package is released. (Nobody knows whether the Troika will even agree to the bailout, or if CDS will trigger.) So, I’m curious to see if the Fed will ramp up POMO purchases to fill a small part of that void during this lapse. The Fed will release its scheduled operations on February 29 at 2pm.

The charts tell a similar tale. The S&P 500 (SPX) is caught near the end of a bearish rising wedge, and that should check to the downside after POMO & LTRO’s shots-in-the-arm:

ES- Bearish rising wedge confirmed by bear MFI divergence.

Also, the spread between SKEW & VIX has quickly reached highs again. That’s indicative of traders forgoing near-the-money option protection in favor of out-of-the-money (tail-risk) hedges. Such a wide spread is consistent with bull markets, although the trough to peak movement is usually more gradual than we’ve seen over the last five months:

SKEW v VIX- Spread between the two is quickly back at highs (associated w bull markets).

Since I’ve trimmed my equity net long position to just over 30%, I find short-term vol attractive at these levels. VIX closed today at 18.19. I may pursue a 3-5% allocation to VXX as a way to hedge out some of my undesired Beta over the next week or two. I plan on being nimble with VXX to avoid any erosion from the constant roll of contracts into a contango curve:

VIX Futures- contango.

–Romeo

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  1. March POMO schedule released: $1B net purchases ($44B buying v $43B selling).
    http://www.newyorkfed.org/markets/tot_operation_schedule.html

  2. […] February 27: The S&P 500 (SPX) is caught near the end of a bearish rising wedge, and that should check to the downside after POMO & LTRO’s shots-in-the-arm. […]

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