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Markets May Be Underpricing Major Risks in Fed, G-20 Events

Joanna Ossinger
(Bloomberg) -- Financial markets are signaling investors see little risk of disruption from upcoming events, despite the potential for major shifts in the course of Federal Reserve policy and U.S.-China trade negotiations.The range of options for this week’s Fed meeting spans a surprise interest-rate cut, a set-up of one down the road or a continued stance of patience, given still-solid economic growth. Late next week, the outcomes of the Group-of-20 summit look binary: either U.S.-China trade talks get back on track, or investors must anticipate further tariff hikes. And the usual run of data must be added to the mix, such as the July 5 payroll report.Yet despite the potential for major market moves from these events, JPMorgan Chase & Co. strategists estimate that the embedded volatility risk premium is “significantly” below its historical average. The group, including Nikolaos Panigirtzoglou, cited a gauge of implied to realized volatility using 12 measures across five asset classes.Other oddities include a large number of short positions on futures tied to the VIX -- the so-called fear gauge tied to U.S. stocks -- and a low amount of hedging as seen in the put-to-call open-interest ratio for S&P 500 Index options, the JPMorgan team wrote in a note Friday.“Option markets do not embed enough cushion against the significant event risk markets are facing over the coming weeks,” the strategists concluded.And then there’s equity positioning, which is still on the high side and vulnerable to a spike in volatility, according to Deutsche Bank AG. Positioning from hedge funds is light on U.S. equities though concentrated in the same stocks as the S&P 500, while in equity futures it’s near the top its historical range, strategists including Hallie Martin and Binky Chadha wrote in a separate report.Systematic strategies “are heavily allocated to U.S. equities and would be sellers on a significant vol spike into a record low liquidity environment,” the Deutsche strategists wrote. Buybacks, which have been supportive of U.S. stocks, will start to run into quarterly blackout periods later this month coinciding with the G-20 meeting, they highlighted.Read: As Threats Mount, Equity Bulls Retain Footing in Tumultuous WeekThere are some markets appearing to gird for stormy weather ahead. Treasuries have been climbing since early May, when President Donald Trump announced he’d expand tariffs on Chinese imports. Five-year notes are effectively pricing in a recession, the JPMorgan analysts calculated. Base metals too are discounting trouble ahead, they estimated.Not so for the S&P 500. The benchmark closed Friday just 2% below its record high from April, and futures were up 0.1% as of 8:17 a.m. Monday in New York. That leaves equities vulnerable to a Fed disappointment. Indeed, one consideration for Fed policy makers is that they might lose the power of surprise should they hold off this week, then lower rates in the aftermath of a negative outcome on trade talks, the JPMorgan team noted.“The resilience of the equity market is in our opinion showing that equity investors have been leaning towards the thesis of a preemptive Fed,” the strategists said. “A more cautious and patient Fed next week could cast doubt on the above thesis, creating the risk of an equity-market correction.”(Adds futures in second-to-last paragraph.)\--With assistance from Namitha Jagadeesh.To contact the reporter on this story: Joanna Ossinger in Singapore at jossinger@bloomberg.netTo contact the editors responsible for this story: Christopher Anstey at canstey@bloomberg.net, Cormac MullenFor more articles like this, please visit us at bloomberg.com©2019 Bloomberg L.P.

(Bloomberg) -- Financial markets are signaling investors see little risk of disruption from upcoming events, despite the potential for major shifts in the course of Federal Reserve policy and U.S.-China trade negotiations.

The range of options for this week’s Fed meeting spans a surprise interest-rate cut, a set-up of one down the road or a continued stance of patience, given still-solid economic growth. Late next week, the outcomes of the Group-of-20 summit look binary: either U.S.-China trade talks get back on track, or investors must anticipate further tariff hikes. And the usual run of data must be added to the mix, such as the July 5 payroll report.

Yet despite the potential for major market moves from these events, JPMorgan Chase & Co. strategists estimate that the embedded volatility risk premium is “significantly” below its historical average. The group, including Nikolaos Panigirtzoglou, cited a gauge of implied to realized volatility using 12 measures across five asset classes.

Other oddities include a large number of short positions on futures tied to the VIX -- the so-called fear gauge tied to U.S. stocks -- and a low amount of hedging as seen in the put-to-call open-interest ratio for S&P 500 Index options, the JPMorgan team wrote in a note Friday.

“Option markets do not embed enough cushion against the significant event risk markets are facing over the coming weeks,” the strategists concluded.

And then there’s equity positioning, which is still on the high side and vulnerable to a spike in volatility, according to Deutsche Bank AG. Positioning from hedge funds is light on U.S. equities though concentrated in the same stocks as the S&P 500, while in equity futures it’s near the top its historical range, strategists including Hallie Martin and Binky Chadha wrote in a separate report.

Systematic strategies “are heavily allocated to U.S. equities and would be sellers on a significant vol spike into a record low liquidity environment,” the Deutsche strategists wrote. Buybacks, which have been supportive of U.S. stocks, will start to run into quarterly blackout periods later this month coinciding with the G-20 meeting, they highlighted.

Read: As Threats Mount, Equity Bulls Retain Footing in Tumultuous Week

There are some markets appearing to gird for stormy weather ahead. Treasuries have been climbing since early May, when President Donald Trump announced he’d expand tariffs on Chinese imports. Five-year notes are effectively pricing in a recession, the JPMorgan analysts calculated. Base metals too are discounting trouble ahead, they estimated.

Not so for the S&P 500. The benchmark closed Friday just 2% below its record high from April, and futures were up 0.1% as of 8:17 a.m. Monday in New York. That leaves equities vulnerable to a Fed disappointment. Indeed, one consideration for Fed policy makers is that they might lose the power of surprise should they hold off this week, then lower rates in the aftermath of a negative outcome on trade talks, the JPMorgan team noted.

“The resilience of the equity market is in our opinion showing that equity investors have been leaning towards the thesis of a preemptive Fed,” the strategists said. “A more cautious and patient Fed next week could cast doubt on the above thesis, creating the risk of an equity-market correction.”

(Adds futures in second-to-last paragraph.)

--With assistance from Namitha Jagadeesh.

To contact the reporter on this story: Joanna Ossinger in Singapore at jossinger@bloomberg.net

To contact the editors responsible for this story: Christopher Anstey at canstey@bloomberg.net, Cormac Mullen

For more articles like this, please visit us at bloomberg.com

©2019 Bloomberg L.P.