Malt Liquidity 5
Uncertain about subtitles, but certain about not having fish for lunch
Fisheries threaten to scuttle Brexit
It is no secret that pound movement generally reflects the changing in uncertainty regarding what the hell is going on with Brexit as the withdrawal process is once again given a ‘hard line’ to finish by the end of 2020. But what’s odd is that an industry that makes up .1% of the UK economy is apparently the major obstacle:
[Foreign Secretary] Raab said while fishing remained the major obstacle, he could see “a landing zone” for a deal on competition rules and state aid -- the other major sticking point -- if the EU is as “reasonable” as the U.K. has been. The EU insists the onus is on the U.K. to compromise…
I really love high quality reporting that informs me that one side in negotiations believes that it is the other’s duty to compromise.
However, in a perverse way, this makes total sense! Brexit, after all, was a cultural referendum - “take back our waters!” is certainly a catchier slogan than “it’s .1% of our economy, who cares”, especially if you believe that fisherman’s rights have been infringed upon in the past to negotiate with similar rationale. Still, it is a good reminder that an obstinate, tiny minority can play such an outsized role in politics outside of the U.S… who knows, the “sea party” may be a force for years to come.
As I talked about last week, though, every single financial product movement has some sort of ‘reverb’ effect across markets, and this is a good case study of how such a small portion of an economy causes uncertainty (read: downward movement) around the pound, which effectively means a strengthened dollar, which causes a drop in commodity prices (simple arithmetic: stronger dollar —> more local currency needed for dollars, as commodities are transacted in dollars —> less ability to transact commodities —> demand, and therefore price, drops). So, oddly enough, negotiations between countries that have very little to do with the global oil market can still materially impact how it moves. Finance!
Uncertain about Uncertainty
There are a few types of large traders, but the ones I commonly tend to focus on the most are either “passive” index investors, the people who outsource all decisions to S&P’s board, or, I don’t know, a Council of Six, and fund managers, who tend to buy and sell when things trend up or down or according to their strategy and prospectus (until that prospectus is totally ignored). A particular form of active manager is the “Scary Jerry”, where, upon any uncertainty, they are smashing the ask and crossing spreads to get out of a position and driving prices arbitrarily lower than they should purely through the size of their trade being larger than the market can support at current price levels. But how much of a premium is Scary Jerry willing to pay to insure his position, if he chose to hedge off risk through options rather than just liquidating his exposure entirely? I came across this paper which sort of states the obvious - options price in political risk if an event’s occurrence spans the life of the option - but also highlights that across their data, investors paid approximately 5.1% extra for political risk protection (in the form of puts), and when economic conditions are also perceived as weak, these options are about 8% more expensive. Put simply, political risk hedging is at a premium, and further increased in weaker economic conditions, which reverberate across tied products in tied countries. The paper is largely a lot of checking the robustness of data that validates intuitive conclusions, but what’s particularly enthusing about such research is that, at their core, financial products are a massive mishmash of linear and nonlinear equations and legalese intended to quantify risk and enable the offloading of it built on top of a single assumption of “let’s just have it work this way.” To see passages such as this one
Another interesting example is the June 2012 Greek election. This election was perceived as crucial for the future of the eurozone, as noted earlier. Our results support that view. The average value of IV_D across all European countries for this election is 6.7%, almost five times the full-sample mean. The countries that were the most affected by this election are Spain (IV D= 10.3%) and Italy (7.7%), which were arguably “next in line” to exit the eurozone after Greece. The effects on Germany and France, the key eurozone players, are also large (7.4% and 7.2%, respectively). In contrast, the least affected European countries are Sweden and Switzerland, neither of which is a eurozone member. Similarly, in the May 2012 Greek election, the largest values of IV_D are observed for Italy, France, and Spain, while the smallest values belong to the eurozone non-members U.K. and Switzerland.
highlight that yes! the products are doing what they’re supposed to!
Sometimes it’s nice to be reminded that, in a lot of ways, the financial product world is doing exactly what it’s supposed to, rather than enabling an endless voyage for the next big short.
On that note…