Part I

Pre-load:

• Critical series of posts about LTRO
• Facts, figures, a few fatuous opinions and a bit of fun
• Part I touches on LTROs we’ve had so far and their apparent effects

Another indecisive session for equity markets, albeit a more moderate one than we’ve had of late, during which stocks and other risky assets have slid alarmingly.

And in Spain, the epicentre of the latest euro-zone worries, the 10-year bond yield remains close to 6%, having recently peeped above that for the first time since November 2011.

Plus, the euro has been threatening another visit below the 1.30 barrier all week.

There’s no getting away from it: the crazy days last seen at the height of The Crisis, in 2011, could still be lurking not too far below the surface of euro-zone markets.

Not that I’ve met many people in this parish and beyond who would be genuinely surprised if that proves to be the case.

The idea that joint efforts by EU leaders, IMF and ECB [via SMP and latterly LTRO] have succeeded in stemming the debt crisis, is questionable, at best, in my view.

Still, it’s a notion which many market participants are happy to play along with while it suits them.

But even if we accept that view, who in the markets wouldn’t want another LTRO?

Markets do seem to be behaving as if they want another one.

After all, their apparent effect on more hazardous markets is well-known and benign.

Markets, are behaving en masse as if they seek to ‘re-live’ these apparent effects, very much like the ‘addicts to central bank funding’ which critics say markets have become.

This underlying desire for more cheap, cash [it’s difficult to imagine why markets would want such a thing] raises the issue of whether the widely held perception of what LTROs achieve is, in fact, valid.

It’s a question which the ECB is likely to consider closely.

Perhaps we should too.

I.e., apart from providing cheap money for over-privileged financial institutions, do LTROs help anyone, or anything else, in any material way?

There’s a widespread suspicion that the perceived effect of LTROs and their actual effects are quite distinct from each other.

And, if LTROs in fact don’t have enough of the effects which are desired, is it really worth chucking another EUR529.5 billion at ‘The Problem?

[EUR529.5 billion was the amount allotted at the second 3-year LTRO, held on February 29th.]

Comments from ECB President Draghi at the press conference which followed the ECB’s last interest rate announcement [rates were kept at 1%] make it clear that another flood of ECB cash has not been ruled out.

But perhaps it should be ruled out.

If it can’t be demonstrated that ECB long-term cash floods help the wider financial system [including individuals and households] that tends to weaken the case for opening the taps again.

Have the LTROs boosted European sovereign bond prices and helped credit expansion in the real economy?

Or has the credit injection just stayed in the banking system to ease the inter-bank credit squeeze and provide funding for bank debt redemptions?

I’m guessing we all already suspect what the answer is.

But fellow market-macroeconomics geeks will take a look at the next post in the series – I’ll tweet when it’s done.

 * The pun ‘LTROver’ has already been used; quoting  the source slightly obviates me from blame.

Quick expectation points from 3 economists at large investment banks whom we expect to be attending the Jackson Hole, Wyoming Symposium:

“We suspect that the Fed is likely to outline a range of potential policy actions that may include the extension of the Fed’s treasury holding maturities, a potential cut in the excess reserves held by member banks at the Fed and changing the composition of the its balance sheet through MBS purchases and Treasury sales.”

“Investors will focus on potential markers and triggers for additional stimulus, in particular regarding the potential launch of a new large scale asset purchase programme (QE3), which we do not expect to be announced at Jackson Hole, or any other policy response such as a lengthening in the maturity of its current portfolio of securities.”

Whilst we do not expect out-right QE3 we think that the Fed has the headroom to “sell short-term securities and buy long term securities in equal amounts. This could lower long-term rates and flatten the yield curve without increasing the absolute size of the Fed’s holdings. But like many such policies, the devil is in the details.”

QuickJPYbullets:

• scope for USD/JPY to plumb/set historic lows with the most recent being 76.37.
• Overnight the pair reversed from a peak around 76.88 and is now at a weakly looking 76.53
• triangle on hourly chart suggests 73.50 target!
• More sensible targets are 76.37 and 75.46

Ahead of the Democratic Party of Japan’s leadership election on August 29, the likelihood of Bank of Japan intervention [on behalf of the Ministry of Finance] looks very limited. 

This comes after the overnight news of Finance Minister Noda setting up an emergency USD100B facility in a fresh attempt to protect the modest export-led recovery from the threat of a continued rise in the yen’s value. 

[The other overnight news, Moody’s downgrade of Japan to Aa3, has been a non-event for markets. Moody’s rating is now on a par with its rival Standard & Poor’s (AA-)]

On the face of it, Japan’s monetary authorities’ choice of this indirect option already looks ineffectual.

But even seasoned strategists in Tokyo have said this morning that the moves partly leave them scratching their heads.

The oddity of the choice of measures centres on the use of the somewhat obscure Foreign Exchange Fund Special Account (FFFSA).

The plan is that FFSA will lend funds of up to Y100bn to Japan Bank for International Cooperation (JBIC) at 6 months JPY Libor rate.

The strategists ask: 1) why the MoF decided to utilise the FFFSA in such an indirect way? 2) why theMoF aims to facilitate M&A at this stage?

They note that in the FFSA account, within Y115trn of total assets, Y3.4trn are foreign currency deposits and Y82.0trn are securities. It’s said a large part of the assets is held in USD-denominated assets, with over 90% invested in government bonds.

Therefore, rather than what we saw today, currency intervention would seem to be the most direct utilisation of the FFSA.

The strategists suggest the possibility of diplomatic considerations in order to “co-operate with other countries’ monetary policy.”

Question two is even more difficult to answer.

Obviously, following the disasters which hit the people of Japan and their economy earlier in the year, the government has instituted many measures designed to buttress the industrial sector. The overnight action seems to be within the same vein - but also looks constrained by the upcoming circumstances of the government’s inchoate status - governing party elections on Monday.

Which brings us back to our original point.

Hence for the short term, given current circumstances, there’s scope for USD/JPY to plumb/set historiclows with the most recent being 76.37.

Overnight the pair reversed from a peak around 76.88 and is now at a weakly looking 76.53.

If we take the textbook to the triangle showing in our hourly chart below, we are faced with a target of 73.50. Common sense alone suggests we need a more cautious one!

Using retracement extensions brings up medium-term targets around the new low, plus a potential newer one, 75.46.

As for the longer term, well, the scope of this post is too small to deal with the fundamental schism - cited by Moody’s in its rating cut this morning - which is stymieing Japanese politics.

Suffice to say that Naoto Kan, the seventh PM in Japan in five years, will have spent just 14 months in office before his exit and the linked article suggests that the ‘revolving door’ in Japanese government doesn’t look to be slowing down just yet. 

Therefore monetary policy and the political stability to both do intervention and to make it count, are at risk of remaining weak.

ThSM

USD/JPY compressed, hourly chart with 100-day moving averages, Bollinger bands and Fibonacci-based retracements

The Swiss National Bank has a USD swaps facility with The Federal Reserve Bank of New York.
On behalf of a Swiss investment bank following a request, the SNB effectively applied for $200M-worth of dollars on Aug. 10 and the amount was redeemed at a rate of 1.08%, Aug. 18.
UBS said it didn’t apply for the dollars.
So we know it wasn’t the recipient.
We don’t know who was (yet) as SNB isn’t saying.
One experienced head in this parish told me the matter hits sentiment mostly - $200M is immaterial, systemically speaking.
And it might some indicate scarcity of USDs, with SNB perhaps not wanting to disburse its own reserves [especially right now - when it’s in an interventionist phase].
 
ThSM

What a weekend.

I sense that many have been reluctant to get involved in the necessary task of trying to work out what the two almost seismic bits of financial news over the weekend mean.

However many did get involved. I’m trying to distil  - in the simplest, essential way possible - the main themes - these are what are likely to have a large influence on what European markets look like in a few hours.

I will concentrate on the potential impacts of the downgrade of US’s long-term credit rating from AAA to AA+, mostly because inception of the ECB news is less solid and corroborated and looks to be still developing.

Sensibly, views about the downgrade appear to be organising into two main strands - short term impacts and long-term impact.


Short term impacts

The first thing to note is that the downgrade event is not a surprise.

S&P did a good job of warning over the risk of a downgrade and the market’s behaviour since showed it explicitly took the threat seriously.

Even so, the raw impact of the change in circumstances and the enormity of that change, even if it was very widely taken as a quite probable risk, are expected to dent risk appetite somewhat on a short-term basis.

There could be some forced liquidation from some money market funds but the sizes involved will not be that significant and provided there are no major distortions in funding markets due to collateral shifts, one may well find that the effects are transient.

No doubt spreads will be wider in the short term and the loss of a risk free ‘core’  could create some number of unintended consequences.

At this stage, The Fed is not expected, at its meeting this week, to make any signals about the possibility of QE3. Teasing out the factors on that issue are perhaps beyond the scope of what I am trying to do here, and rather quickly, so I’ll leave it at that.

On the other hand, as we know, news suggests Europe’s central bank has decided to act in response to the downgrade although it has chosen to fire artillery it kept in reserve last week.

The news is that the ECB is moving closer to purchasing Italian and Spanish sovereign debt, in an effort to stem the spiralling yields of the two.

The daily run rate of bond buying is estimated to be on average around EUR2.5 billion, equivalent to an annualised rate  of EUR600 billion if maintained over time. In the short term, the ECB intervention is seen as likely to be a fillip to business and consumer confidence, but long term more fiscal austerity and weaker growth are seen a price that has to be paid in a deleveraging cycle.

Also, it’s feared that any attempt to stop the bond purchase programme will lead to renewed dislocation and the ECB will be forced back in as buyer of last resort.

In terms of Treasuries Investors: On Monday, cash-flush and not yet long investors [the majority] are expected to act accordingly.

Even after the 125bp rally in 10-year paper since early April. Dips will be bought. Monday’s close rather than the open is seen as more important to assess the near-term path of rates. Key support and resistance levels to watch in 10yrs today are: 2.33% and 2.865%.


As for forex.

Both AUD/USD and USD/CAD are singled out as likely to retrace further back to parity next week. Both commodity currencies were already under pressure this week.

As for ‘our’ EUR zone

So far, the euro might even be bid! It’s certainly up on the European close. This might not signify anything material however, participation would be on the marginal side at this time of day in any case: throw in holiday effects and just plain old common sense and of course volume is likely to be thin, right now.


EUR is trading close to 1.4375 following Friday’s close at 1.4282, while AUD commenced about 50 pips lower. The CHF move is, as one might expect given the recent trend, the most pronounced with USD/CHF dropping almost 200 pips soon after commencement.

USD/JPY, is having just another day at the office and is well within the recent range - towards the top of it in fact.

Back to the US, the USD and the Long Term Impacts


There has been a consistent trend towards lowering USD holdings by reserve managers for a number of years and while there is no substitute globally at this point in time, the process of diversification is sure to accelerate and could particularly help currencies like the AUD or GBP.


However no major [if any]  forced selling of Treasuries, GSEs, or other fixed income instruments is expected.


Good luck.

ThSM

Meet Dr. Ed Yardeni.

Apart from being a most accomplished independent, economist practitioner, with private practice, and corporations and even small nations as clients, he is also known in parts of the financial world as a co-inventor of the Fed Model.

Regular readers of his blog, and more specifically, his client-only forecasting and research know him as a pragmatic optimist; much more sophisticated than a market bull, but effectively, on ‘the bullish’ side.

Alas today, in ‘Dr. Ed Terms’ if you will, looks to have been a dark day.

Not just because of the day’s tumultuous market events.

It might actually have been even worse than that.

Even before any of the day’s market routs, he downgraded his assessment of the outcome of the year in broad equity market terms.

Naturally, even his downgrades are measured and still afford room for reasonable optimism.

But downgrade it was.

As I said, his forecasts are usually client-only content.

It’s only permissible to quote brief excerpts, hence the following is short.

But it’s quite enough.

“I am now officially lowering my year-end target to 1250, unchanged for the rest of the year and for the entire year. I’m still expecting some improvement in economic growth during the second half of the year in the US. I’m still forecasting that the S&P 500 will earn $99 per share this year and $105 next year thanks to opportunities for more revenues and earnings growth overseas. I am predicting that the forward P/E will remain around 12. However, there is probably more downside risk than upside potential in the valuation multiple.”

Deutsche Bank: solid as a Black Forest oak. But could it fail stress tests?
 
The idea that it might outright or nearly fail the EU tests is gathering pace and adding a small chill to European markets right now.
 
The results are coming out at today, 1600 GMT.
 
Failure is a possibility according to analysts, considering the application of full CRD III  [Capital Requirements Directive]  from the Basel II Compliance Professionals Association.
 
Banco Popolare and Commerzbank would also be ‘near fails’.
 
The full impact of Deutsche Bank as a ‘near fail’ does not look fully priced in the CDS markets.
 
DB reported a Basel 2 Core Tier 1 ratio of 9.6%, 31 March 2011.
 
Adding €93bn of market risk-weighted assets, as per the Basel 2.5 requirement, results in a reduction of approximately 210bps to their Core Tier 1 ratio (Basel 2.5 is incorporated in the CRD III requirements).
 
And adjusting for a possible 100-to-150bps impact of the adverse stress test and DB may move into the near-fail territory.
 
Naturally, markets are jittery enough already.
 
In the test results, if there’s anything like the extent of bad news about a major conglomerate northern European bank failing the tests, as some in the market fear, perhaps look for #EUR #USD to head toward the neckline of the previous head and shoulders on the hourly chart around 1.4033 from current 1.4138.
 
ThSM

Risk. Without another full-blown financial crisis, could most parts of the financial markets be any riskier right now?

Hence the perennial search for assets to add which serve to reduce risk.

You might like to take a look at this chart. Hint: you can view without downloading.

Sorry, it starts from last year and ends in April ’11, but I still think it’s instructive.

Using Bloomberg data, Citi put together a model of a 50-50 EUR+CHF basket and a 50-50 EUR+SEK basket — the data are indexed to March 2010 =100.

Look at the way that up to Spring 2010 – inception of ‘peripheral euro zone crisis’ - the trades are like a band of brothers.

After that, EUR+CHF became the clear outperformer.

Bearing in mind long-term USD weakness and hence the need to underweight USD, it’s arguable that sovereign and ‘real money’ [no really! Actual cash!] accounts can long Europe [which might be unavoidable – see ‘real money’] short USD and circumvent the ‘peripheral crises to a great extent.

EUR/CHF traded 1.21901 +0.92% on the day at 1822 GMT

ThSM

Euro tumbled out of Asia into domestic markets amid feverish talk that Greece was verging on a snap election after the opposition there voted against latest austerity plans.
Stabilization came around 1.40132 with reports of demand near 1.4025 - sovereign demand talk again.
Greece eventually denied there would be an election, giving  EUR an extra fillip.
And more from a trading floor nearby: a “nasty short squeeze,” not long ago.
It coincided with Finland voting in favor of bailing out Portugal - True Fins or not.
Then equities edged off lows as the groundless panicky tone faded.
The floor is punting on stops near the high in Asia: 1.4107, although flow is neutral so it may not be hit.
DXY flirted with important 76.00, 38.2% retracement of fall from 81.31 to 72.70.
But then it demurred.

RBA Hawks may have Long Hop in store

The Reserve Bank of Australia’s Governor Stevens has created quite a conundrum ahead of its rates decision Tuesday,  in Asia-Pacific trading hours, 1430 AEST/0400 GMT

He was very hawkish over the weekend.

And AUD/USD twice tried 1.10 Monday in Europe, but failed. Also, RBC Capital Markets says only 1/22 analysts it polled see a hike, “and no hike is even remotely priced in.” It says the nearest support was observed at 1.0925, with trailing stops seen near 1.0915/20.

In the event of a sell-off, strategists of one of the Big 5 say they’re looking to buy dips toward 1.0900. “Below here, our orderbook is stacked with bids down to, and below the important 1.0600 pivot.”

With the pair currently down a few ticks from the current session high which was 1.095000, the market seems in no major hurry to take RBA’s threats seriously just yet, but still seems poised for any relative ‘surprise’

ThSM

The saddest news is that there are at least 44 reported fatalities so far from the severest earthquake to strike Japan in 140 years.

And it looks inevitable that that number will rise.

The 8.9 magnitude quake struck Japan’s northeast coast sending a tsunami wave at least 10-metres high into coastal areas of Japan. The wave may also hit regions of the Philippines, Taiwan and Indonesia.

As for the internal and external economic impact - we will have to wait for tighter assessments as it’s still too early and reports of the core event and the aftershocks are still trickling in.

In the meantime, the most immediate financial response meriting attention has been the Japanese yen’s relapse into definitive weakness from a position which was already ambivalent. The yen had crawled back toward moderate strength in recent days in recovery from recent surprise credit rating downgrades of the country’s sovereign debt and an uncertain political picture.

But following the quake, technical chart analysts are noting that the rate has suffered a significant setback off 83.30 and as I write, they note it’s at key projected support near 82.16.

Loss of 82.16 is said to imply the risk of 81.95; with 82.85 needed to negate that risk. 83.09 is said to be necessary for Friday’s high at 83.30 to again be feasible.

As for the more medium-term economic picture, a keyword which economists in this parish are citing is “repatriation.”

It seems like the risk of emergency repatriation of funds originating from Japan, in order to boost reconstruction, is greater than outright economic costs from damages and insurance [although of course these part of the picture in Japan itself.]

One economic specialist on Japan this morning did in fact query the potential downside for the yen from the quake.

“Japan has a very low level of foreign creditors, and there may actually not be much scope for JPY weakness, ” they said.

On the other hand they added: “It will be interesting to see whether or not the financial and insurance impact of this quake causes a more rapid repatriation of funds and foreign currency asset sales.”

The major equities benchmarks are right now [Wednesday afternoon] extending the slide which they commenced earlier this week, after simmering uncertainty over the situation in the Middle East tipped over definitively into ugliness – with authoritarian crackdowns in Libya at the fore, prompting another rush to the exit from ‘risky’ assets.

This week’s swing in markets to a general ‘risk-off’ stance follows what seems to me, a rising murmur of commentators over the last few months calling for an overall correction in major risk markets, principally stocks.

For instance, take a look at this skit by renowned market watcher Paul Farrell.

He’s experienced enough and savvy enough not to fall prey to modish opinion on the downside or upside. But he even goes so far as to call a “market crash” for later this year:

As for myself, I don’t know if this is a market correction or not. If you’re looking for a definitive answer – please stop reading – I don’t claim to have one!

Still, it can’t do any harm to look at some ‘red flags.’

Last week I noticed some Goldman Sachs equity trading strategists quietly published some views after conducting a similar exercise.

Amongst the things which Noah Weisberger, Kamakshya Trivedi, Dominic Wilson and Aleksander Timcenko pointed out were:

• 10-day realized volatility in the S&P 500 had reached around 5.
•  Portuguese yields at or close to all time highs above 700 basis points – remember Portugal sovereign debt has been the most recent whipping boy of players of the  euro zone peripheral sovereign debt meltdown. 7% appears to be the interest rate at which the ECB sends in forced help, judging from the recent experience of Ireland.
• The latest Merrill Lynch fund manager survey shows staggering results with a major capitulation in emerging markets, extreme bullishness on equities and extreme low levels of cash.
•  Developed markets re-pricing interest rates judging by interest rates futures, after years of ZIRP – zero interest rate policy – suggesting that a meaningful shift of policy taking place…
• And of course, protests in the Middle East continue to gather pace.
• General activity across ‘European 1’ [a rather elitist definition of the most ‘developed’ parts of Europe] delta [basically risk-seeking behaviour] has slowed. “This latest attempt to break out is taking place in thinner volumes than we have seen all year,” Goldman’s strategists noted
• They also saw something in the significant outflows from leveraged short US equity ETFs - following heavy inflows in prior weeks. They saw that as “negative from contrarian perspective…we believe the reversal could be signaling a near-term market top because our research shows that leveraged ETF flows are a superior contrary indicator.”

Beyond the no doubt highly partial view which the largest investment bank in the world is promoting [at least to clients] an interest rates strategist in this parish noted the front-month contract of the US 10-year Treasury futures was testing a 5-month downtrend on technical charts – at the same time as stocks were also “toying with critical supports…I don’t think we need to see a great deal further down in equities to see some asset reallocation back into bonds from stocks.”

However he was at pains to also point out that “bond bulls/equity bears have been disappointed before over the past couple of months, so it is worth considering buying a 10 delta call spread for a decent risk reward.”

Another balanced voice was that of a US independent economic consultant who has many governments, investment banks and wealthy individuals as clients.

“Last week, I reiterated my recommendation to overweight oil and gold given the proliferation of chaos in the Middle East, which has a long history of chaos.”

[His writing is well-known to be wry, sardonic and not too reverent.]

“I should have specified Brent crude oil, which jumped 2.2%, while WTI crude oil trailed with a gain of 0.7%. Among the precious metals, I should have picked silver, which jumped 6.6%, outperforming gold’s 1.4% gain.”

Aside from careful selection of sectors, he pointedly did not provide any globalized bearish cautions with respect to risk markets.

(Or, why front-month S&P 500 Variance Futures rose 41.36% on Friday.)

For whatever reasons, it seems clear right now that the largely moderate North African states, including Egypt, and their ideological and geographical cousins on the fringes of the Middle East are likely to face days of reckoning in the next few months.

I leave the subject of causality to students of international relations and geopolitics.

Instead, I want to concentrate on how the sudden eruption of events characterising them were reflected Friday in the way the long-dormant VIX Volatility Index exploded back into life, closing with a 24% gain at 20.04, the largest rise since May 20.

Of course U.S. Treasuries prices and the dollar, the so-called ‘safe havens’, also rallied.

What we have is a classic, suddenly-emerging geopolitical ‘risk event’. It’s characterised at least by the facts that the outcome and the consequences [and the geographical reach] are unpredictable.

Such events tend to prompt investors to rush to the exits of ‘risk markets’. And that’s often concomitant with the type of jump in the CBOE’s VIX Volatility Index which we saw on Friday.

Market professionals widely assume that such gains in the index imply the return of ‘fear’ after a long period in which the market relaxed to such an extent that it was greatly at ‘ease’ with a long climb upward over an extended period.

As we know, encouraged by the Fed’s just as ‘easy’ policy, gains in many major benchmarks approached 20% over the last six months.

And the longer such a period of gains continues, the closer the feet of market players get to the brakes, in readiness for the time to stop dead.

That time, most likely arrived on Friday.

That’s a safe enough summation. But, it’s not the whole story.

I don’t want to claim that I know the whole story, but I want to look a little closer and beyond, at the commonly accepted view of how things work in general during times like these.

The first thing I want to remind you of is that whilst many call the VIX the ‘fear index’, that is of course not its official name. And the reason why it’s not the official name is because ‘fear’ might not be precisely what the index measures in any material way.

As the Chicago Board Options Exchange says in one of its education ‘Research notes’  (5.1.09, Issue 2):

“While it may be a handy nickname, ‘the fear gauge’ is really a bit of a misnomer and, when taken too literally, may lead to some confusion. It is important to remember what VIX truly measures: the stock market’s expectation of future volatility implied by S&P500 stock index options prices. In other words, VIX uses options pricing as a way to measure perceived market risk and uncertainty.”

In its paper, the CBOE seems to allow for the possibility that ‘fear’ and ‘uncertainty’ might well segue into each other and even overlap at times, to such an extent that they appear indistinguishable. But the Board seems to want to make it clear that even if that’s the case, the two qualities are not the same thing.

Once we understand that ‘fear’ is not necessarily the characteristic which VIX measures, even if gains in the index often correlate with a quality of increased fearful behaviour in markets, we can start to see that if the VIX jumps 24% it’s also a time of opportunity, for some.

The other major thing I want to note is that despite the VIX index’s gain on Friday, it was not the biggest gainer in the CBOE’s brace of volatility indexes on that day.

It’s telling us something that the largest gain was actually in the front-month contract of CBOE’s S&P500 Variance Futures. [The ticker symbol is VT/HI].

CBOEVAMAR11 [the March contract of S&P 500 Variance Futures] rose 41.36% to 249.50 [higher than the last delayed quote on CBOE’s website].

OK, but what exactly is that telling us?

Well this is where we take another small step beyond the common beliefs which underlie our basic day-to-day market activities.

Introducing Lewis Bicamp and Tim Weithers.

They are respectively Head of Financial Engineering and Director of Education at Chicago Trading Company LLC.

They remind us that  “Even though volatility is the more commonly used term in the financial markets and media, an asset’s volatility is actually derived from its
variance.”

We don’t have to go back to school and get our heads round formulas to understand this.

In practical terms, if you already understand what volatility ‘does’, then you understand what an asset intended to capture ‘variance’ does too.

Helpfully, Messrs. Bicamp and Weithers also point out that “CBOE variance futures contracts are essentially the same as an OTC variance swap” contract.

The main difference of course is that the former are exchange-traded, with all the benefits that brings. (For one thing, we can see when people are piling into them!)

I want to use the technicians’ words again because they explain the potential uses of these contracts much more succinctly than I can:

“In principle, any institution which seeks to hedge or speculate on volatility might want to strongly consider trading variance, either in the form of an OTC variance swap or a CBOE variance future….some businesses have natural exposure to volatility that could be reduced by trading variance swaps.”

In the end, just like protesters in Egypt seeking greater freedoms, anyone involved in financial markets also needs to ‘be careful out there’ right now, during this time of heightened risk.

At the same time, it’s interesting to be aware that much bigger figures in the background are probably capitalising on the extremely fluid nature of the outlook.

References 

‘VIX - Fact & Fiction’ (Research Notes Issue 2, May 1 2009) The Research Department of The Chicago Board Options Exchange

’S&P 500 Variance Futures’ Biscamp, L. and Weithers, T., Chicago Trading Company LLC

I’m not a great fan of City of London colloquialisms, but one term is sticking in my mind today.It’s how traders and analysts etc. around here, informally refer to the success of a corporation or a state, in bond offerings.[Some of you will know where I’m going with this now, but humour me please.]
They say, if a bond offering is deemed to have gone well that Such-and-Such Corporation or government, has ‘got away’ the offering well.The phrase fits a second set of much-watched bond offerings in the euro zone today - after Portugal’s yesterday - very well. But it also makes me think of a similar phrase, ‘to get away with’ something, thinking about both Italy and Spain, which sold bonds today and the euro zone too.
As with Portugal yesterday, there’s no doubt today’s European bond auctions should be deemed successful. Italy ‘got away’ EUR3B in BTP Nov15 and EUR3B BTP Mar26 and EUR6B, which puts the result at the top end of the planned range.                                             Demand was stronger than at a similar sale in November. The 5-year paper attracted 1.41x bid-to-cover and the 15-year 1.42x.
Once again, however, we need to note the gains in interest rates, with yields at 3.67% for 5-year and 5.06% for 15-year. 40 basis points and 25bp increases compared with November, respectively.
Still, Spain also, ‘got away’ the maximum amount it planned - EUR2-3B.  Again demand strengthened compared with the November auction, with Spain registering a 2.1x bid-to-cover vs. 1.6x in November.But yes, the market demanded more in terms of risk premia from Spain too: 4.54% in yield, almost 100bp more than November.
Predictably, the euro has rallied more today, following these prima facie successful auctions,  with EUR/USD having broke back above the psychological 1.30 mark earlier this week, it added the best part of another 3 euro cents from late morning to late afternoon [piercing the 50-day moving average on the 6-month chart, by the way.]
In terms of trading, it’s logical to expect that there could have been triggers [stops] around these levels, which could take us back up to near where a reasonable gap was opened on November 22nd around 1.36, but with concomitant downside risks too.
Like the the euro, Spain, Portugal and Italy, have got away with it too - but with an inevitable ‘for now’, also.
There is the matter of the rather unreal-looking funding costs demanded from the states offering  bonds this week. Yields can hardly be considered normative, given that the European Central Bank is very likely to have been helping to mop up liquidity at these auctions, not to mention the on-the-record contributions from China and Japan.And like the euro, the euro zone faces some more near-term challenges before we can speak of the crisis being over.Next week, Portugal and Spain will hold T-bill auctions and Spain will sell SPGB Oct20. Plus Spain has announced that it will sell a new 10-year bond via syndication over the next few weeks.Ideally these need to go well and yields need to start retreating before the risk of another bailout from the EFSF can be ruled out.Headlines indicating early-stage talks to expand the euro zone’s emergency funding facility might just represent moves to ensure sensible insurance is in place. But they also of course implicitly raise the perceived risks.
ThSM