17 September 2008

The Fear Gauge

Today was the most fearful day in the markets that probably anyone living can recall. Gold surged 11%. Banks essentially stopped loaning money to each other. At one point banks were so scared that they were willing to invest in 3 month U.S. government debt (which they can use as collateral in case of disaster) for 0.03%, essentially for free. This was the lowest rate anyone has seen since the Second World War. The Vix, a measure of the amount of volatility traders expect over the next thirty days, reached its highest point since the crisis began last July. Since its inception it has only been this high twice, once during Russia's default on its debt in 1998 which caused the largest hedge fund collapse up until that time, and once during 2002. At its current level the Vix indicates that the S&P 500 will move up or down by 10.4% over the next 30 days. My personal feeling is that this is either the end of things as we know it or the worst its gonna get, staring into the precipice wise. Since I've been expecting Armageddon for since 2006 the fact that it hasn't happened yet is encouraging. Also despite the extreme stress in almost all markets, the Japanese yen which has typically surged during times of crisis has remained steady over the past 2 days. Finally, for the past 14 months it has been profitable to bet on volatility declining every time the Vix has broken 30 on an intra-day basis. I believe it is extremely unlikely that the Vix will break 40. That said, I have no idea what other policy initiatives the central banks of the world will pull out of their pockets. They can't just make bad loans good, and despite the massive injections of liquidity into the markets, there is no way that temporary liquidity can solve credit problems. Oh and by the way, the Federal Reserve has run out of money and has asked the Treasury to begin borrowing money on its behalf so that it can continue to function

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