Gregory Marks's picture

SNB: Restoring Price to the Market

On January 15th, 2015, we witnessed a 15 standard deviation event in the EURCHF* and USDCHF market. For those unfamiliar with such terminology, a 15 standard deviation event would be unlikely to occur in your lifetime. It is not to say it is impossible, but on a relative basis it's pretty impossible, especially when putting it in the context of the most liquid market in the world: foreign exchange. 

What is the likelihood of a 15 standard deviation event? Here you go:

So the probability of occurrence is roughly 1 in (1.36*(10^50)), also equal to 1 over Bremermann's Limit (the minimum size of encryption keys that would be needed in order to create an algorithm that could never be theoretically solved). In the world of risk management, a statistical model would suggest you worry more about getting struck by lightening or asteroids than a 15 standard deviation event, so feel free to bet the farm. It may seem silly to think about recent foreign exchange price action this way, but here we are just giving a voice to the models that run portfolios and risk management around the globe. This sort of logic is now embedded as a fundamental foundation of financial markets.

It would seem as though we could characterize this event as unnatural in a number of ways. Unnatural in its occurrence, but more importantly unnatural in its root cause. After all, over the last few years the Swiss National Bank has been playing God with prices in order to control flows and volatility in the CHF market.

Years of this sort of intervention conditions market participants and models into discounting impossible events. Another example of this conditioning can be found in the run-up to 2008, where policy promoting ever increasing home prices led to VaR models that never considered falling prices. With current monetary policy around the world out to suppress volatility and support asset prices, what sort of conditioning is occurring under the surface?** As my former colleague, Kristian Kerr, at DailyFX asks, is the true ‘bubble’ out there simply in the belief that central banks have everything under control?

I would tip my hat to the SNB for restoring 'the market' to the Franc if it weren’t for the fact that this action was taken most likely to facilitate manipulation by the European Central Bank in the EU bond and Euro market.

By no means am I a believer in efficient market theory. Our emotions, human psychology, group think, these things all stand in the way of unbiased and true pricing. Equilibrium is arbitrary, but I nevertheless remain confident that markets do a better job in pricing than any other alternative.

At the same time, when prices and volatility are controlled or guided by monetary authorities with (what appears to be) unlimited reach, all that is bought is time. History has shown us that volatility and the natural cycle of prices can never be dismissed, only mitigated in the short run, packaged and shipped to a later date. 

Of course there will be some economists who say this move was out of weakness, but may I remind them of the prerequisite that is an assumption in their models: a free market. Returning price to the market is a noble endeavor; it should have never been taken away. 

*(I have heard some dealing in the interbank market was as low as the mid 60s. This would have been a 21 standard deviation event.) 

**(Shiller on the decades that equity prices did not rise in real terms.)


Gregory Marks's picture

Crude Move: Portfolio Reallocations and the USDollar (II)

            The saying goes that it’s a 6 lane highway into emerging markets and a bumpy one road out. We might have to adopt that expression here, but apply it rather to all high yield Dollar and non-Dollar assets that have been bid in the grand reach for yield, including crude and associated business lines. Equities lead consensus on the street and the continued push to all time highs has disguised the disconcerting price action in crude, foreign exchange and high yield. It is time we address that price action here, even if it remains a side note in monetary policy minutes.

            What we are witnessing, and what the crude move and foreign exchange is telling us, is that the market is unwinding positions and reallocating portfolios at once. Let’s take a step back and look at the process logically. Every single time the US monetary authority has spoken of higher rates, after a little volatility and Fed-speak backtracking, markets have dismissed it. If volatility spilled over and impacted economic data or home prices, the monetary authority would step in. In the US QE1 was followed by QE2 and then QE3- the latest including an outright purchase of not only Treasuries, but mortgage backed securities as well. In China, a brief decline in home prices brought about renewed infrastructure spending, further keeping emerging markets and commodities bid. In Japan, a full fledged- almost all out- endeavor to devalue the Yen, boost asset prices and fight deflation remains underway while in Europe calls for QE continue following rate cuts, LTROs, negative deposit rates and a recent asset purchase program. Additionally, the Financial Times reported this summer what was long suspected by operators on the street: “A cluster of central banking investors has become major players on world equity markets.”

            On the whole, things since the crisis have remained consistently inconsistent, but market participants have continued to position themselves with the understanding that (1) US rates would remain low and (2) an implicit backstop is always around the corner- a force ready to suppress volatility, keep asset prices bid and inspire confidence in risk taking endeavors. Not only that, but a guarantee of low rates out of the premier, safe haven currency monetary authority has prompted one of the largest borrowing of greenbacks to buy higher yielding assets in history. The amount of Dollars borrowed for this endeavor are staggering, including loans from banks abroad totaling over 3 trillion USD. As recently as this summer we saw the trend push speculative positioning to all time highs, with market participants even piling into assets that drove the last crisis.

            In recent months, something has changed. Looking at Fed Funds futures contacts we see that rate hike expectations have not faded (yet) as they would have previously. At the same time equities have remained bid and data (at least on the payroll front) has been improving. The market is taking rate hikes out of the Fed seriously this time. Whether the monetary authority realizes this or not, in seriously hinting at higher rates, they are triggering a massive USD short squeeze, commencing a process by which investors holding higher yielding assets in USD denominated debt are caught on the wrong side. This energy move does not stand alone; it is rather a domino in the process.

            The recent move in crude is a testament to the massive portfolio reallocations taking place under these conditions. The portfolio of the last five years is in direct conflict with the portfolio of the next five years under the assumption that a rate hike cycle in the US begins while the rest of the world lags. Regardless if the rate hike cycle sustains itself (it didn’t last time), market participants cannot wait and find out. Participants see what the Fed is saying (‘the market is under-appreciating the rate hike timeline’) and managers have no choice but to actually take this seriously and reallocate their portfolios accordingly. Even for those who do not believe the rate hike cycle will occur, they are currently being caught on the wrong side of one of the largest moves we have seen in some time, both on a percentage and value basis. Such unwinding exasperates the move and prompts everyone to hop on board or be subject to an expensive hedging bill or call from the margin desk. This set of circumstances constitutes a paradigm shift.

            As a fund manager, why would it be desired to hold commodities that deliver no yield in an environment of rising rates (damaging to asset prices)? Why would commodities that deliver no yield wish to be held in an environment where the currency it is priced in (USD) is set to appreciate in value as US rates supposedly rise? Plain and simple here, crude is a product priced in a currency that is set to appreciate, with a central bank responsible for that currency on a policy path diverging in a hawkish manner from all others. It is a product that appreciates when demand, and thus global growth, overshoots expectations (in other words not the current case). 

            Over the last 6 months euphoric and overextended markets have actually, at least in the US, been met with the start of some strong economic data. Has the economic data improved based on strong fundamentals, or has the economic data only just improved after five years of low rates and incentives to take risk? If the latter, what will rate hikes mean for economic data when it disrupts the market side that likely drove it (or at least gave it confidence)? If rate hike expectations fade out of the US with an increase in volatility or disruption in asset prices, how will global markets respond when all participants attempt to shift allocation in the opposite direction once more, forcing some to liquidate and others to move to the sidelines as to wait out volatility? Or, if this is the real sustainable deal here and revolving credit and the money multiplier are set to expand, how will the Fed reduce the money supply without throwing the global economy into a recession?

            These are the questions the investment community (and monetary authorities) face, but are not asking or fully appreciating. Market participants are asking what is driving the move in crude, rather than seeing where the move is coming from, seeing that it is a symptom of much larger fundamentals. 

            In 2006 the US was an economy that had both an overheated economy and overextended market. When- at the final hour- the Federal Reserve began to adopt a rate hike bias, the house of cards fell apart. Now, through five years of volatility suppression and the refusal to tolerate unbid risk assets, we seem to be going into a rate hike where markets are overextended, but the economy is just starting to print a few decent quarters of data. As history tells us, the further we diverge from the mean, the faster and farther we fall when portfolios rebalance (or volatility prompts a run for the exit). Once again, this move in energy is not taking place in a vacuum. While the cause of this crude move is debated, what is missing from the debate is the origin driving it- an unstable reallocation by all parties at once after five years of low rates and purposely undisturbed reach for yield. 

Read part 1 here:

Gregory Marks's picture

Crude Move: Portfolio Reallocations and the USDollar (I)

The recent increase in volatility, particularly in foreign exchange and commodity markets, has prompted speculation and confusion as to the direction of prices. In regards to crude, many see the down move in a traditional supply vs. demand context, making the case that demand has decreased with global growth expectations while production out of the US has increased the market supply. Both of these facts are correct, but this still does not address the driver of the recent (and extreme) move itself. Those fundamentals noted have been in play for some time now. It is not as if market participants woke up in June (energy high) thinking to themselves, "Today, I will trade WTI futures rationally considering supply and demand fundamentals.”

            Divergences can build for tremendous periods of time, stretching price from fundamentals while surviving on momentum, expectations or asset allocation extremes. Nevertheless, prices do not occur in a vacuum. In the case of energy, higher prices fed upon higher prices. Diverging above the historical mean brought in players, spurred production innovation and thereby capacity. Even the economic impact of the production itself helped nations on the trade balance, employment and GDP front thus projecting expectations of higher demand thereby supporting price even further. Additionally, OPEC did not shy away from this new price regime, taking the opportunity to boost domestic spending or makeup for terribly structured budgets eroding under excess spending and inefficiency. (On a side note, capacity driven by the higher prices that OPEC welcomed now likely means a lower average price, straining state budgets of petrodollars when most needed.) 

            In the discussion of crude, it is important to note that such a commodity does not experience a 38% decline in under a year because of those fundamentals that have been around for years. Moves of this nature occur because of (1) a rapid change in expectations and (2) a subsequent, large move to reallocate positions by all players considering those changes. If we want to understand those two factors, we must first start with the building of the commodity super-cycle and and the fundamentals that sustained price.

            Commodity super-cycles have occurred in various times during history, the most recent one in energy having been driven by the rise of China and easy money driven global growth. Leverage, low rates, higher input costs and a weaker Dollar can all be included in the basket of drivers. Additionally, a consistent increase in the price of crude beginning in 1999 and the investment abilities that followed the rise of the internet drew an increase in speculators. It wasn’t long before the commodity turned into an asset, a well known and easily investable product to include in a portfolio, be it a pension fund or the average Joe’s online brokerage account.

            As we know with prices that never seem to go down, they keep going higher! A classic strategy of George Soros, among others, remains that when a bubble is spotted one must pile in. (Macro funds often admit guilt in propagating bubbles by taking part in this strategy.) Charles Prices’s comment about ‘dancing so long that the music is playing’ would be the more the metaphorical and well known illustration. 

            And higher crude went, hitting highs above $140 a barrel until topping with a USDollar low in the summer of 2008. I will spare readers of the events that followed, well known to all, better summarized by others and unnecessary to reiterate in detail. In our discussion of crude, what matters is the 21st century version of ‘the committee to save the world’ backstopped global markets, bringing a return of some normalcy to volatility and confidence in systemically important institutions. That was on the market side. On the economic front (important to distinguish the two) we received a US stimulus package in the hundreds of billions of Dollars, followed by an even larger and more potent package in the trillions out of Beijing. This came later, in 2009, when it became clear what a dire social and economic impact declining growth would mean for the mainland, emerging markets and the world. This defibrillator, combined with quantitative easing measures and a commitment to low rates, brought ‘life’ back to prices. Monetary authorities nervously hoisted the ‘mission accomplished’ banner, but continued unprecedented measures in the fight against deflation. Meanwhile, the market began what would become a five year global hunt for yield, borrowing reliable Greenbacks at low rates.

            Challenges ensued starting with Greece in 2010 followed by the rest of the Eurozone bond market in 2011 and the Chinese property market in 2012. Regardless, volatility suppression out of global fiscal and monetary authorities kept the boat afloat and Dollars cheap. Despite rough waters, a ‘do whatever it takes’ attitude pumped out the water, but without addressing structural cracks in the hull. And so established the dominant logic: if we could only return normally to the uptrend in assets through an expansion of monetary base, we might be able to get out of this economic and fiscal mess alive. Market participants played along, allocating investments in logical areas that would benefit from such a policy with once again, cheap Dollars.

Read part 2 here: 

Gregory Marks's picture

Non-Standard Measures Are Risking Stability

As someone who manages a foreign exchange and macro ETF portfolio, when central bankers are speaking I am likely listening. Although some financial media sources exaggerate the impact that these voices have on day to day market fluctuations, those who set monetary policy can have a large directional impact on interest rates around the globe. Those shifts in interest rates vis-à-vis policy or forward guidance adjustments often create ripples throughout money markets, global equities and foreign exchange rates. 

But where did these mechanisms of setting interest rate policy come from? As detailed in the Lords of Finance (a Financial Times and Goldman Sachs Business Book of the Year), in November 1910 a group of financiers gathered in Jekyll Island to form what would become the Aldrich Plan. This plan led the groundwork for the Federal Reserve Act that passed Congress in 1913 and established a central bank for the United States, the Federal Reserve. 

Lords of Finance focuses on the history of monetary policy and central bank creation in the early 20th century. The author, Liaquat Ahamed, goes through copious amounts of research to identify the faults of these early central bankers during the Great Depression. Ahamed takes the view that those at the Federal Reserve and Bank of England failed to take extraordinary measures to prevent such an economic collapse. Those views may sound familiar as a recent scholar of the Great Depression, a man by the name of Ben Bernanke, found himself in a similar situation as those early central bankers. Bernanke argued and continues to argue that the events of 2008 warranted unprecedented measures (they did) and that a failure to do so would have repeated the Great Depression on an even larger scale (correct as well). 

Although Lords of Finance rightly criticizes central bankers of the past for doing too little, the next Business Book of the Year focused on monetary policy may likely argue that central bankers of the last few decades have done too much. 

This is the view I hold despite the fact that it goes in the face of current central bank forecasts and opinion. This is also the view of former managing director of the IMF and current Reserve Bank of India governor Raghuram Rajan. As the Financial Times notes in their recent summary of Raghuram Rajan's latest comments, there is currently a build-up in risks that have directly resulted from central banks’ unprecedented measures, of which are in the fifth year of implementation. 

A recurrent problem among central bankers is that they are often behind the curve. Because a majority of monetary policy makers are career academics or have remained in a central bank capacity, their experience in markets is limited in comparison to those on a trade or strategy desk in the private sector. Economic models cannot predict a crisis and if they can it is already too late. It takes a comprehensive knowledge base in market flows, psychology, technicals and structure to identify a mismatch between price and underlying medium-term fundamentals. 

“Financial sector crises are not as predictable [as those of economic growth].” Rajan said. “The risks build up until, wham, it hits you.” 

(I have respected Rajan for some time now. He was one of the only central bankers sounding the housing alarm in 2005 while others were highlighting the ‘strong fundamentals’ to prices. Earlier in the year I shared my confidence in him as head of the RBI and argued that the Rupee would likely strengthen into 2014, although in April I highlighted an overvalued Rupee where INR could weaken versus the greenback into the third quarter). 

It is important for market participants and policy makers to listen to Rajan at this critical juncture. On almost every structural, technical and strategic basis I observe, I see a dangerously overextended environment much like Rajan. Economic models can view risky assets in the context of inflation adjusted price over time, but they fail in the most crucial capacities. Economic models cannot predict the evaporation of liquidity and the circular intensifying of selling momentum during demand, price and rate shocks that come with it on average every five to six years. A low rate environment, although in place to boost demand/prices, help overextended financial institutions and reduce longer-term unemployment/rates, also has the impact of boosting shorter-term leverage, risk taking and the appearance of liquidity.

Although no one can profess to predicting the future, the idea that this can be unwound steadily is, to quote Rajan, “…a big hope and prayer.” Although the Lords of Finance during the Great Depression did too little to avoid catastrophe, we cannot ignore what may be the result if today’s Lords of Finance have done too much. 

Gregory Marks's picture

Islamic Finance

Source: The Economist

Sharia Law, presented in the Quranic versus, provides a body of moral codes by which Islamic persons must follow. In practicing nations, these codes are religious law and address standards ranging from crime and prayer to etiquette and economics. 

As detailed by the Financial Times in May, the economic side of these sacred codes is what multi-cultural financial hubs (notably London) have their sights set on currently. Only one western nation has issued a bond that is in line with Sharia Law under the condition that no interest payments are involved: the UK. 

To those with knowledge of the City, this comes as no surprise. London has not only represented itself as a financial capital along with New York, Hong Kong and Singapore, but it has notably served as a second home for Middle Eastern businessmen and their families - not to mention its hub status in the trading of petrol and metals. 

Amid a world containing complex financial structures, contracts and lending vehicles, one would think that building a bond that adheres to Sharia Law would derive from an intricate financial innovation of sorts. As it turns out and as the Financial Times describes, ijara is a simple sale-and-leaseback structure. The 'precious metal middleman' format leaves London well positioned and it is no doubt that business will grow over the coming years.

But will London become a prime hub for this sort of financing or will the City give way to an emerging hub of the east? Will we see larger institutions take a lead here or will added scrutiny in the structures leave smaller, local institutions better positioned? Sharia scholars have voiced concerns and lenders and borrowers alike may be walking a fine line when faced with traditionalists. Will the next generation of borrowers and lenders reflect back on sharia as a former "obstacle" or will this moral hybrid remain the standard? 

Feel free to answer any of the questions I've outlined or contribute your experiences when it comes to Islamic finance. For those who have lived in a country where Sharia Law is practiced, how would you analyze public opinion on the matter?


Be sure to check out this great Financial Times article on Islamic Finance: 
Islamic finance: By the book 

(Graph: The Economist)

Gregory Marks's picture

AIC - Student Loan Debt

On Thursday I had the opportunity to ask Dr. Bullard of the St. Louis Federal Reserve about the unsettling increase in student loan debt. This is particularly an important topic for those in the Project Firefly network, especially those in the United States.


Current estimates point to the fact that we have crossed the $1 trillion mark in outstanding student loan debt. In my opinion these figures may be overstated slightly due to fraud, but US government subsidies in interest paid on these loans actually underestimate the true costs in the medium to long term. We must remember also that unlike other debts, bankruptcy law in the United States makes clear that by declaring personal bankruptcy one is not free from those debt burdens.


Although the magnitude of these $1 trillion in liabilities are not yet felt by markets, they are unlikely to be 'felt' in the traditional market shock manner. Instead, this sort of debt acts as a slow and steady drain of this generations' purchasing power. Like many, I currently have teachers that are still paying down their student loan debts. Tuition prices have certainly grown since their time in university and prospects have diminished among those 'traditional' industries.


When posing the question to Dr. Bullard, I made clear to emphasize the complacency among students in regards to these loans. Undeclared juniors with over $50,000 in debt are not uncommon and this complacency is not only irresponsible, but fiscally dangerous.


I think we are all advocates for investing in ourselves and investing in our future, but we must not grow complacent and we must understand the growth of our respective majors. Nine of the top ten fastest growing jobs in the next decade are in the technology, programming and mathematic related fields. The growth of those respective majors in the university system have not kept up.


It may be naive to think that my question will make a difference. If anything, the question was rhetorical and not completely answered as central bankers remain careful in their public statements. Still, there is hope that in his discussions with universities and the FOMC committee, he will remember my question and may be more likely to highlight the risks. That is my true hope and small contribution to this and the next generation. Although monetary policy does not strictly deal with the issue of student loan debt, central banks are responsible for the economy and this generation will prove that those debts are important to recognize by policy makers. 

Gregory Marks's picture

The AIC from the Inside

It is without a doubt that with those in attendance managing an estimated $17 trillion dollars, what is said and discussed at the annual Credit Suisse Asia Pacific Conference matters for global markets, sentiment and cross border flows. If pure capacity of the various attendees is not already impressive, the extensive list of speakers and moderators include top Credit Suisse strategists, directors of various organizations such as the WHO and IMF as well as former prime ministers. 

Seeing as my topic for the 2014 Project Firefly Emerging Leaders competition was in regards to the Fed’s ‘tapering’ of its third asset purchase program, my interest has been mainly in those former and current central bank speakers and attendees. The remarks by many have been candid and I had the opportunity to speak with and ask questions to a former RBI governor as well as the relatively controversial, former European Central Bank executive member Dr. Jürgen Stark. My particular question to Dr. Stark, which he answered straightforwardly as I expected, was in regards to the recent onslaught of European government bond issuance in 2014. Thus far we have seen some European countries already go through 50% of their 2014 issuances and we are only in March! Dr. Stark was on board with my perception that these nations could be front-running risks later in 2014 with current and attractive rates.

By far the theme of the conference is cautious bullishness in the West while Asia may have a tough few months ahead. Mirroring my own opinions in regards to Chinese and Japanese growth, many in attendance are worried. The consensus on China is that there are tremendous risks in 2014 and in my discussion with one of Credit Suisse’s strategists, we both agreed on the fact that if we see RMB truly rocket above 6.25 or we see nominal rates rise above real GDP, the risks could be unleashed quickly. 

One of the more insightful and enjoyable panels was Tuesday’s Asian private equity discussion. The men chosen to attend the conference were pragmatic in their approach to markets and blunt in their honesty. Considering myself a macro person, the insight into individual countries and the various valuations in the Asia Pacific region helped broaden my knowledge base on a geographical area that I am little exposed to in New York. With Wednesday marking the half way point here at CSAIC, I am looking forward to asking the head of the Reserve Bank of Australia (Mr. Glenn Stevens) as to his rate expectations post-Australian rebalancing and whether he sees rates in Australia returning to pre-crisis levels.