Macro and Flows Update: January 2024 - e25

Summary

The video discusses the structural flows in financial markets from November 1st to January 17th, highlighting the significant impact of buybacks, reinvestment, and lower liquidity during this period. It warns of potential market risks due to the decline in the reverse repo facility and the potential for a supply-demand imbalance. The speaker advises being cautious and considering long volatility strategies, especially during critical market windows like the one around February. The video also emphasizes the importance of being nimble and hedged in the face of potential market downturns.

Takeaways

• 📅 The video update focuses on the market dynamics from November 1st to January 17th, highlighting the structural flows that occurred during this period.
• 📈 There was a significant market rally predicted from November 1st to January 17th due to factors like lower volume weighted time, big open interest, and corporate buybacks.
• 🔄 The structural flows that contributed to a 15-20% market increase from October lows have now subsided, leading to a potential market decline as the support from these flows is no longer present.
• 💹 The video discusses the impact of interest rate hikes and treasury issuances on market liquidity, noting that the effect has been minimal due to the Federal Reserve's reverse repo facility.
• 💰 The reverse repo facility, which has acted as a liquidity buffer, has significantly declined from trillions to about 500 billion, indicating a potential supply and demand issue that could affect risk assets.
• 🚨 The speaker warns that the liquidity imbalance is currently underappreciated and could lead to adverse effects on equity markets unless the Federal Reserve intervenes.
• 📊 The script mentions a significant increase in market participants buying volatility products, indicating a shift towards expecting market turbulence.
• 🔮 The concept of Vana and Charm, related to market buybacks and option decay, is introduced, explaining how these factors have helped balance the market in the past.
• ⏰ The video identifies a 'dangerous window' for markets, specifically from January 17th to February 3rd, where liquidity imbalances could lead to a steep market decline.
• 📉 The speaker advises being cautious and considering long volatility positions during the identified period of potential market weakness.
• 📅 January 31st is highlighted as another important date due to a significant Fed meeting, which could bring more risk and volatility to the markets if they are down heading into the meeting.

Q & A

What was the anticipated period of the market rally mentioned in the script?

The anticipated period of the market rally mentioned in the script was from November 1st to January 17th.

What structural flows were significant during November and December according to the speaker?

The significant structural flows during November and December included big open interest, lower liquidity due to the holiday season, substantial buyback and reinvestment of collateral, and markets being up significantly.

Why is the period after January 17th considered muddy or uncertain?

The period after January 17th is considered muddy or uncertain because the structural flows that supported the market rally have subsided, and the support is no longer there, leading to a potential decline in the market.

What is the role of the reverse repo facility created by the Federal Reserve?

The reverse repo facility created by the Federal Reserve has been used as a source of liquidity by the Treasury, particularly by issuing shorter duration securities. It has helped to offset the potential negative liquidity effects of interest rate hikes and issuance over the past several years.

What is the concern regarding the supply and demand imbalance?

The concern regarding the supply and demand imbalance is that the significant decline in the reverse repo facility, from multiple trillions of dollars to about 500 billion, could create a massive supply and demand issue, potentially leading to adverse effects on broad risk assets, especially the equity market.

What is the significance of the February options expiration for market behavior?

The February options expiration is significant for market behavior because it has historically been followed by a decline in the market. The script mentions a massive decline four years ago from the day after February Opex to the day after March Opex, which is considered a dangerous window for markets.

What is the role of Vomma and Veta in the market?

Vomma and Veta are related to the decay of volatility and Vega as time passes. Vomma refers to the decay of volatility, while Veta refers to the decay of Vega. They are important during expiration cycles as they contribute to a reflexive loop that leads to the buyback of the market of the underlying as volatility compresses and time passes.

Why is the period around Valentine's Day considered dangerous for markets?

The period around Valentine's Day is considered dangerous for markets because it is a time when market makers and dealers are decaying longer implied volatility options and volatility, which can dampen the market. If there is continued buying of volatility products by institutions during this time, it could lead to an imbalance in the supply of volatility, potentially causing market instability.

What does the speaker suggest about the market's behavior after January 17th?

The speaker suggests that after January 17th, the market may enter a period of decline due to the subsiding of the structural flows that previously supported the market. The speaker advises being cautious, nimble, and considering playing from the long volatility side as a hedge.

What is the significance of the January 31st Fed meeting?

The January 31st Fed meeting is significant because it is anticipated to be a major event with substantial risk pricing in the markets. The speaker notes that there is a lot of risk and volatility associated with this meeting, and it could lead to more negative flows if the market is down going into the meeting.

How might a decline in the 10-year interest rate affect structured product issuance?

A decline in the 10-year interest rate could lead to a decrease in structured product issuance, which has been a significant supplier of implied volatility. If this supply starts to dissipate, it could have an adverse effect on the market, as the stabilizing and supportive impact of the V supply could be reduced.

Outlines

00:00

📈 Market Analysis and Structural Flows

The speaker begins by providing a market update, discussing the prediction made in October about a rally that was expected to last until January 17th. The prediction was based on analyzing the structural flows in November and December, which included big open interest and volume weighted time. The speaker notes that these flows were not fundamental and have now subsided, leading to a potential decline in the market. The discussion then shifts to the impact of interest rate hikes and treasury issuances on market liquidity, highlighting the role of the reverse repo facility by the Federal Reserve in managing liquidity. The speaker expresses concern about the potential risk of an imbalance between supply and demand, which could negatively affect broad risk assets, especially the equity market. The speaker suggests that the Federal Reserve may need to intervene to prevent this liquidity imbalance and advises viewers to keep this risk on their radar.

05:03

📊 Volatility Products and Market Dynamics

In this paragraph, the speaker discusses the recent activity in the market regarding volatility products, such as the purchase of 300,000 Feb expiration VIX calls and vertical put spreads in the SPX. The speaker explains the concept of Vomma and Veta, which are related to the decay of volatility and Vega over time. The speaker notes that these forces have been balancing the market and preventing it from becoming overly imbalanced due to the buying of volatility. However, the speaker warns that once the January options expiration passes, the supply of volatility to counteract buying will decrease, potentially leading to a market imbalance. The speaker also references a significant decline four years ago, indicating that a similar event could occur again, especially during the February to March window, and advises viewers to be cautious during this period.

10:03

🏦 Federal Reserve Meeting and Market Implications

The speaker discusses the upcoming Federal Reserve meeting on January 31st and its potential impact on the markets. The speaker notes that this meeting is significant and that there is a lot of risk associated with it, including the potential for increased volatility and open interest. The speaker also mentions that if the market is down going into this meeting, it could lead to more negative flows at the end of the month, exacerbating market moves. The speaker then talks about the importance of interest rates and structured product issuance, explaining that a decline in the 10-year rate could lead to a reduction in the supply of volatility, which has been a stabilizing force for the markets. The speaker concludes by emphasizing the precarious nature of the current market situation and advises viewers to be nimble and cautious, particularly during the identified periods of potential market weakness.

Keywords

💡structural flows

Structural flows refer to the systematic and predictable movements of capital in financial markets, often driven by factors such as corporate behavior, economic cycles, or regulatory changes. In the context of the video, these flows are highlighted as significant forces that can influence market direction, particularly during periods of lower liquidity. The speaker mentions that these flows were instrumental in a rally from November 1st to January 17th but warns that their subsiding could lead to a decline in the market, as the support they provided is no longer present.

💡liquidity

Liquidity in financial markets refers to the ease with which assets can be bought or sold without affecting the asset's price. High liquidity means that there are many buyers and sellers, leading to a more stable and active market. The speaker in the video emphasizes the importance of liquidity, noting that a decrease in liquidity can lead to an imbalance between supply and demand, which could negatively impact risk assets, especially in the equity market.

💡Federal Reserve

The Federal Reserve, often referred to as the Fed, is the central banking system of the United States, responsible for implementing monetary policy to promote economic stability. In the video, the Fed's actions, such as the use of reverse repo facilities and quantitative tightening (QT), are discussed in relation to their impact on market liquidity and the potential for creating a supply and demand imbalance.

💡quantitative tightening (QT)

Quantitative tightening is a monetary policy tool used by central banks, like the Federal Reserve, to reduce the money supply in the economy. It is the opposite of quantitative easing and typically involves selling government bonds or other financial assets that the central bank holds. In the video, the speaker discusses how QT and the issuance of treasuries have not had a significant liquidity effect on markets, which is attributed to the reverse repo facility.

💡supply and demand imbalance

A supply and demand imbalance occurs when the quantity of goods or services available (supply) does not match the quantity that consumers are willing and able to purchase (demand). In financial markets, this imbalance can lead to significant price fluctuations. The video emphasizes the risk of such an imbalance due to the decline in the reverse repo facility and the absence of structural demand, which could adversely affect broad risk assets.

💡volatility products

Volatility products are financial instruments that are designed to profit from or hedge against changes in the level of volatility in the market or in specific securities. They often include options and futures that are based on the VIX index, which is a measure of expected volatility. In the video, the speaker notes an increase in the purchase of volatility products, indicating that some market participants are anticipating higher market volatility.

💡Vana and charm

Vana and charm are terms used in the video to describe specific market dynamics related to option trading and market behavior. While the exact definitions are not provided in the transcript, they seem to refer to market behaviors that occur as volatility (VA) compresses and time passes. These concepts are part of a reflexive loop that impacts market makers and dealers, influencing the supply and demand for volatility products.

💡Veta and Voma

Veta and Voma, as used in the video, appear to be terms related to the decay of volatility and Vega (a measure of the volatility of an option's price) over time. These concepts are important in understanding how market makers and dealers manage their positions as time passes and how they decay longer implied volatility options, which can influence market stability.

💡interest rates

Interest rates are the cost of borrowing money and are determined by central banks or the market, depending on the economic context. Changes in interest rates can have a significant impact on financial markets, affecting everything from bond prices to stock valuations. In the video, the speaker discusses how changes in interest rates can influence the 10-year Treasury note and structured product issuance, which in turn affects market dynamics.

💡market decline

A market decline refers to a period when the prices of financial assets, such as stocks, bonds, or commodities, are falling. This can be due to various factors, including economic data, geopolitical events, or changes in market sentiment. In the video, the speaker warns of a potential market decline due to liquidity imbalances and the absence of supportive structural flows that had previously driven the market up.

💡macro flows

Macro flows refer to large-scale movements of capital or changes in the economy that are influenced by macroeconomic factors such as fiscal policy, monetary policy, economic growth, and global events. In the video, the speaker has been tracking macro flows since November 1st and has been successful in predicting market movements based on these flows. However, the speaker now advises caution as the previously supportive macro flows are no longer present.

Highlights

The video update discusses a critical period starting from November 1st to January 17th, marked by significant structural flows in the market.

These structural flows include less volume weighted time, big open interest, and the reinvestment of collateral due to market performance.

The speaker anticipated a rally that would last until January 17th, and as of January 18th, the prediction appears to be accurate.

The support from the structural flows that took the market up by 15-20% has now subsided, leading to concerns about the market's future direction.

The speaker highlights the importance of liquidity and its impact on supply and demand in the market, especially in the absence of structural demand.

The Federal Reserve's reverse repo facility has been a key factor in managing liquidity, but it has significantly declined, raising eyebrows about potential imbalances.

There is speculation about the Fed potentially stopping quantitative tightening (QT) early due to the looming liquidity issues.

The speaker notes a shift in market dynamics, with a rise in buyers of volatility products and an increase in vega and implied volatility.

Vana and charm, which describe market behavior as volatility compresses and time passes, are contrasted with MOA and Veta, which relate to the decay of volatility and vega.

The speaker warns of a potentially dangerous market window, particularly around Valentine's Day, due to the expiration of options and the associated open interest.

The video emphasizes the need for caution and nimbleness in the market, especially during the identified periods of potential weakness.

The Fed meeting on January 31st is highlighted as a significant event that could influence market flows and volatility.

The speaker discusses the impact of interest rates on structured product issuance and the potential for a change in the market's volatility supply.

The video concludes by reiterating the importance of being hedged and prepared for potential market downturns, especially during the outlined timeframes.

The content is not intended to provide investment advice, and viewers are encouraged to consult with their advisors for personalized guidance.

Transcripts

hello and welcome back to another macro

and flows video update here we are in

January uh important juncture we've been

talking since about

October of what would likely be a

November 1st to third low and a rally

that would really take us till a date I

circled on your calendar is January

17th um here we are on January 18th uh

you know why did we pick that out just

to review massive structural flows in

November and December that our function

of less volume weighted time big open

interest so the Vana and charm flow is

not only accelerated but quite bigger

than usual lower liquidity during that

time of the year um particularly big uh

buyback and reinvestment of collateral

that happens as a function of the market

being up significantly in a year with

they 25% up Year all of these flows were

significant and we foresaw these

November 1 1st till January here

17th now the picture gets a little bit

muddier right this is not when the crack

is coming to be clear I circled that

date on the calendar really trying to

tell you guys the window opens now for a

decline so all of these structural flows

which are not really fundamental flows

that took us up really about 15 20%

about 20% now off the bottom there in uh

at the end of October have now subsided

and the support is not there anymore

what does the other side look like of of

liquidity does that does does that mean

we're going down or does it not that's

what really determines the net Supply

Demand with no structural demand per se

coming in and that is an area of concern

that's something I want to highlight

today um if you look at the raising of

interest rates and the issuance um

that's come um on over the last several

years the issuance from treasury has had

very little liquidity effect to date on

markets and this been a bit puzzling for

some people like all the QT that's been

done all of the issuance that's been

done why have we not had more negative

liquidity coming from uh from macro

flows and the answer is due to a

facility that was created several years

ago called reverse repo by the Federal

Reserve that was repurposed and used and

has been tapped for liquidity by

treasury by issuing shorter duration

treasuries however if you look at that

reverse repo what has happened to it has

significantly declined as a buff offer

now down to about 500 billion from from

multiple trillions of dollars and by

most measures that should be uh work

through that liquidity should be worked

through on the short end within months

uh call anywhere from three to six

months um that creates a massive supply

and demand issue um it's uh raise

eyebrows at the FED uh you've start

started to hear some talk about uh

stopping QT early as a result this is on

a few entities radar but not fully

appreciated in terms of the risk of

imbalance between supply and demand that

exists as a function of this um and

without the structural demand and the

flows that were there at the end of the

year and that will not be here really in

a meaningful way really until late next

year maybe nine months from now there is

the beginning of a window of kind of

payback without the supportive flows

right as this buffer of liquidity is

starting to narrow and that liquidity

imbalance

um is really a risk that is being

underappreciated at this moment unless

the FED does come to the rescue and

react early um to counteract this

liquidity imbalance um you would expect

this liquidity really have an adverse

effect on Broad risk Assets in the

equity Market being one of the primary

um entities hurt now again the FED can

get out in front of this and and we have

to Be watchful for whether or not they

the community communicate more clearly

that they will be doing this proactively

otherwise markets will force the fed's

hand so that's the important thing to

keep on your radar at the same time

we've reached this point in the cycle

we're starting to see massive now buyers

Who start are starting to see this um

has happened massive buyers of B not of

the market of of volatility products

300,000 Feb expiration vix calls 16 17

18 strike uh calls were bought just last

week um vertical put spreads 30,000 Plus

in the SPX um at a pop institutional

cash sprads buying Vega and long-dated

put something that we haven't seen in

quite some time and that has been

pushing up uh Vega and implied

volatility for the last several weeks um

that said it's been held under control

that VA increase and even the decline

that we've seen even kind of the

shakiness we've seen in markets more

recently has been held under control by

a very important Force something I don't

talk to much about but called voma and

Veta you hear us talk about Vana and

charm all the time I think most of you

now know broadly what that is uh Von and

charm is the buyback of of the market of

the underlying as V compresses and as

time passes but MOA and Veta are the

Decay longer of volatility and Vega as

time passes that's Veta and voma as VA

decreases um and that's a very important

thing during these expiration Cycles as

part of a reflexive Loop that leads to

Morana and charm again confusing words I

know but the important takeaway here is

as time passes past these meaningful big

expirations like the J Opex which is

about to be done market makers and

dealers are decaying longer implied

volatility options and volatility which

is dampening and that allows them also

that that liquidity and and volume of

volatility product Supply to offset the

VA buying that's happening otherwise so

this has been balancing the the market

and allowing the market not to get

imbalanced in terms of a v Supply to

dealers that said this V Supply buying

is is generally very weakening to the

volatility position and once we get past

if that continues once we get past this

jary options expiration that Vol Supply

that's been coming on will will uh

decrease um and if there's continued

buying there will be less supply of

volatility to counteract the buying of

of B that has been happening by

institutions more recently so Something

To Be watchful for it is not a

surprise again I've talked about this

but it's been a while that we had a

massive decline four years

ago from the day after February

Opex 30% to the day after March

Opex that is not a coincidence that

happened due to massive open interest in

the March expiration uh we knew about

covid all the way back in December uh

and early in Jan January but yet we

rallied as a market Vault continued to

be compressed and until the flows were

bled out and and participants were not

prepared for it we we rallied and then

the market sold off 30% and almost

exactly a month uh expiration cycle um

that Feb to March window I believe and

again I'm not talking about this

publicly but in the macro flows here for

you guys I want you to guys understand

that that window is likely the most

dangerous window um the Wednesday before

Opex uh right around Valentine's Day um

is a very dangerous very very dangerous

period for markets the window is open

here January 17th and in this short one

and a half to two week period if we can

get a decline that decline that I've

talked about due to those liquidity

imbalance factors we've talked about can

begin and then can extend through that

fed march to create a longer more

painful

decline but if it doesn't begin now the

odds increase for a steeper more

dangerous decline come February much

like we saw in

2020 so time to be careful we've been

very bullish and optimistic about

markets given those macro flows since

November 1st but now the window opens it

is time for caution time to be nimble

time to play from the long volatility

side and to be

hedged so um now to be clear Feb 17th to

about yesterday till about uh sorry Jan

17th to to about February 2nd or 3rd is

the current window if we don't get

enough uh Vol you know uh increase

during that period some beginning of

some downside weakness to unpin markets

then you have to be constructive from

around Feb 2nd or so all the way till

February 14th so about two weeks and

then comes that window again where

things get dangerous um but again these

are your two months this is your window

and we're not going to keep rolling from

month to month if it doesn't happen here

Feb and March they the period becomes

way less um constructive for the longv

case and for the market decline case so

really time to be nimble particularly

these two sets of two weeks during these

windows of weakness during this window

um and if we don't get it U we're not

going to be uh stubborn or dogmatic

right but this is the time to play um

from that side um uh important we also

have January 31st we have a very big fed

meeting uh with a largest event B we

have seen in over a year that's the

markets are pricing so significant risk

and and there is a lot of risk that

comes from aent there's a lot of v and

charm that comes off it initially but

there's also a lot of open interest that

can create more risk and volatility for

markets so also an important date to

follow up on there if the market is down

going into J 31st um that would also

lead to more negative flows on the end

of the month which could exacerbate

moves during that window as well so

another thing to Circle and think about

as we move forward the next couple of

weeks um if we get past that window

again February 2nd or so um time to be a

bit more constructive um but uh but we

believe there will be opportunities from

the short side between now and

then uh lastly interest rates have come

down quite a bit the 10 years has come

down from over five to uh you know what

below four and now I'm back above four

but if this continues to be the case if

we the market does sell off if um those

things lead to a temporary decline in

the 10year again or at least a continued

uh uh you know 4% or lower kind of level

in the 10year in the next several months

um it's important to note that

structured product issuing something

we've talked so much about which has

been the steady kind of uh uh imbalance

on balance kind of supplier of all that

has helped to keep implied volatility

and all supplier well uh um well

supplied um that can start to dissipate

and it doesn't happen overnight and it's

not going to be something that breaks

the market but that is the proverbial

Dutch boy that had his thumb in the Dy

holding back kind of these negative

flows this V supply has been very

stabilizing and supportive for the last

year and a half um if that starts to

break that is a major issue if the Dutch

boy has to go home to grab lunch or he's

hungry and he's been sitting at that

wall for too long and is not being fed

um the the Water behind the wall can you

know prbly prbly uh begin to have an

adverse effect on Mar markets so

something to watch We're measuring that

looking at that closely um particularly

with uh the seasonality and the lack of

sub uh demand for markets that we see in

this period and those other macro um

Supply uh of like you know of of

issuance um coming on market and the

risk that that presents um so very uh

precarious moment um after what's been a

very good productive move in markets

that we have luckily you know been able

to to get out in front of um the been

really playing both the decline October

September October the the rally no

December mid January very well um can't

get them all right but when we hard to

be more spot-on than we have been in

that regard um again this is the time to

turn more cautious and to more be more

long volatility there are significant

risks that sit out there um and uh worth

uh worth taking a step back and being

hedge and if anything playing

proactively from the short side going

forward here

um so as we look for potential impending

be nimble uh wish you all the best for

the next month uh until next time be

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