Obama created an unnecessary financial crisis. Not that we would have escaped eventually having one, but he played like a fool into the Republican desire to use the debt ceiling to push for budget cuts, and he tried outsmarting them to get his long standing desire of entitlements cuts through. Having the S&P downgrade hit when the Eurozone crisis was in an acute phase was like rolling a car full of explosives into a burning house. “Obama victory” may come to be the modern version of “Pyrrhic victory”.
And the man touted as a silver tongued orator can’t even talk up the markets. He actually managed to talk them down. Big time.
As numbed readers no doubt know, the S&P closed down 6.66%. BAC fell a stunning 20% on the day and its CDS spreads are up big. The VIX rose over 50% to 50. The FT Alphaville (hat tip reader Scott) point out that the VIX is backwardized. From their chat with Christopher Cole of Artemis Capital (boldface theirs):
In regard to VIX futures curve backwardization since 2004 the front two contracts of the VIX futures curve have traded at a discount to spot VIX approximately 25% of the time. Currently the entire VIX futures curve shows inversion and this shape has only occurred 13% of the time since 2004. Negative convexity across the entire curve usually only occurs during systematically important shock events such as the 2008 financial crash, Bear Stearns bankruptcy, 2010 flash crash, and the 2007 credit market meltdown.
It is important to understand the fundamental and structural dynamics underlying VIX futures curve inversions. The traditional explanation is that VIX futures curve backwardization implies the market’s expectation of volatility mean reversion or that the VIX will decline from elevated levels. An alternative explanation is structural, implying that investors who bought VIX futures and options as tail risk insurance are now all rushing to “cash-in” on the payout at the same time, artificially pushing the curve downward.
This may explain the mixed forecasting record of the VIX futures curve in backwardization as the spot VIX has breached the discounted VIX futures price to expiry only 62% of the time since 2004. The average duration of a VIX futures curve backwardization is only 4 days, however when the entire curve in backwardization implying a systematically important event, the curve can exhibit negative convexity for much longer periods including 64 consecutive days of full curve inversion during the 2008 financial crisis.
Or to quote the financial maven Bette Davis, “Hang onto your hat, we’re in for a bumpy ride.”
I’ve started #ReasonsToPrimaryObama. The Wrongway Prez needs to be replaced, and we need alternatives beyond the ones being served up by the Republicans.
This post originally appeared at naked capitalism and is reproduced here with permission.
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