There’s something tragically ironic about the prevailing market narrative.
Day after day, week after week, the punditry regales us with tales of “the future”, where “the future” is represented here in the present by “disruptors” like Amazon, Facebook, and of course Bitcoin. “Just buy the damn robots,” we’re told. “Get in on the (block)chain of fools while you still can,” crypto proponents implore.
In reality, the market has succumb to short-termism. What you’re seeing on a daily basis is the subjugation of the future to a near universal myopia fostered by policymakers. Not only are investors not taking a long-term view, extrapolating about the future has become well nigh impossible. Horizons have not expanded. On the contrary, they are shrinking every, single day.
Central banks have are attempting to manage the risk associated with an exit from the post-crisis policy regime by engaging in an almost real-time consultation with markets. That’s the goal of forward guidance. Transparency is the name of the game and the idea is that being predictable helps mitigate the myriad risks associated with unwinding the monetary policy experiment.
The never-ending parade of speeches, interviews, and trial balloons from developed market central bankers turn policy into a kind of rolling plebiscite. Rate hikes must be fully priced by the market so there’s no chance of a surprise. Have a look at the market pricing going into this cycle’s Fed hikes:
That’s deliberate. If you look at how the ECB’s October taper announcement was telegraphed, you can see how this can become an endless regression. Even the telegraphing was itself telegraphed. The discussion about what would be announced in late October had been playing out for months with policymakers leaking different possibilities to the press and observing how the market reacted. That amounts to a consultation with market participants. It’s a two-way communication loop that effectively allows the market to co-author the policy script.
The problem with this arrangement is that the policymaker reaction function isn’t well defined. How could it be? It depends in no small part on how markets react to the suggestion that policy will be tweaked. The market’s role in this ensures that the whole process lacks any semblance of determinacy. There’s no end game. It’s not a preset course dictated by data or any other reference point for that matter. Rather, it’s an evolving narrative with two authors - policymakers and markets. When trying to take account of this arrangement, markets must take account of their own role. Investors then, must try and conceive of themselves as a determinant in the policy outcomes that will shape markets. It’s a mindfuck. And coming full circle, it has the inevitable consequence of shrinking horizons.
Because no one can see outside the communication loop, no one can take a long-term view of central banks. There is no long-term view. There is just tomorrow or at best, the next policy meeting where the conversation will revolve around what markets expect. Unless you’re the Bank of Canada, the idea of hiking when it’s not fully priced by markets is unthinkable. Indeed, policymakers have even resorted to micromanaging the situation when they think markets have “misinterpreted” some errant comment in post-meeting press conferences or some throwaway line in the meeting minutes.
If you are confused as to why volatility spikes are “mean reverting” more rapidly than ever before or if you are baffled when it comes to explaining why risk premia continue to compress, this is why. This is the narrative that explains why “BTFD” has gone from being a joke to being a viable “strategy.”
I’ve used this chart from BofAML twice over the past two weeks, but I’ll use it again:
Volatility spikes now fade faster than ever before as the vol. sellers re-engage almost immediately. Shocks are now alpha opportunities. You cannot survive in this environment if you do not adopt the same short-term thinking. Taking a long-term view entails foregone carry and underperformance in a world where every basis point counts. This dynamic optimizes around itself. When investors search for yield and sell vol., dealers who take the other side of the trade need to hedge and that hedging can serve as a buffer against large drawdowns (long gamma). Thus, near-term stability is reinforced further.
As Deutsche Bank’s Aleksandar Kocic puts it: “the future is degrading into an optimized present.”
We all know that “those who cannot remember the past are condemned to repeat it.” But what about those who cannot remember the future?