Equity Index Update
Brad Sullivan
This morning the indices are trading sharply lower on the heels of a mini-crash in China where the market lost -9% of its value in their Tuesday session. In addition, the unwinding of the Yen Carry Trade has begun in earnest as the YEN is higher by +1.2% vs. the Dollar overnight. I have said for quite sometime that this is the key, the liquidity primer that has become one of the primary reasons for the decrease in global volatility. Now…if this Carry trade turns into a fiasco of “last one turn out the lights” it will have major negative implications across the global index and commodity markets.
Given that I have laid out the bear case, it is worth noting a couple of key points. IF THE YEN CARRY UNWINDING IS MODERATE IN NATURE, the markets should have little trouble adjusting to this liquidity squeeze. On the flip side…all one needs to do is examine a chart from last years steep selling in the index market --- REMEMBER IT ALL BEGAN WHEN THE YEN RALLIED SHARPLY VERSUS THE DOLLAR ON COMMENTS OUT OF THE BOJ REGARDING THE END OF THE EASING CYCLE. Granted, the subsequent rally was tremendous and has carried the indices to new trading highs. However, being a short term trader we are concerning ourselves with the outlier event…and that is volatility. If I am correct, I suspect that today will usher in a several week period of increased volatility - time to put away the sunscreen or ski boots.
As volatility begins to come back into the marketplace, it will widen the true depth within the bid/ask. We have grown accustom to size up at every tick in the index futures markets – this will subside as market maker programs adjust for the uptick in volatility. Subsequently, this will increase the impact a large order has on the market – for example, an order to sell 1500 sp minis at the market during a liquid time of day may only move the index a couple of ticks. Today, that same order could move the market as much as 1.75. Be prepared for strong program playing and liquidation. In addition, be ready for some quick and aggressive short covering moves.
