gaining the edge - understanding market dislocationsasia)-gai… · pzh consultants © 2020 pzh...

PZH Consultants © 2020 PZH Consultants Pte. Ltd. All rights reserved.

CME Group (Asia) presents:

Gaining the Edge - Understanding Market Dislocations

Thomas Poh – 4th May 2020 www.pzhconsultants.com


Futures trading is not suitable for all investors, and involves the risk of loss. Futures are a leveraged investment, and because only a percentage of a contract’s value is required to trade, it is

possible to lose more than the amount of money deposited for a futures position. Therefore, traders should only use funds that they can afford to lose without affecting their lifestyles. And

only a portion of those funds should be devoted to any one trade because they cannot expect to profit on every trade. All references to options refer to options on futures.

Swaps trading is not suitable for all investors, involves the risk of loss and should only be undertaken by investors who are ECPs within the meaning of section 1(a)12 of the Commodity

Exchange Act. Swaps are a leveraged investment, and because only a percentage of a contract’s value is required to trade, it is possible to lose more than the amount of money deposited

for a swaps position. Therefore, traders should only use funds that they can afford to lose without affecting their lifestyles. And only a portion of those funds should be devoted to any one

trade because they cannot expect to profit on every trade.

Any research or trading views expressed are those of the individual author and do not necessarily represent the views of the PZH Consultants or its affiliates.

PZH Consultants is a trademark of PZH Consultants Pte Ltd. The PZH Seal Logo, PZH, are trademarks of PZH Consultants Pte Ltd.

The information within this presentation has been compiled by PZH Consultants for general purposes only. PZH Consultants assumes no responsibility for any errors or omissions.

Additionally, all examples in this presentation are hypothetical situations, used for explanation purposes only, and should not be considered investment or trading advice or the results of

actual market experience.

None of the authors , contributors, administrators or anyone else connected with PZH Consultants in anyway whatsoever can be responsible for any losses and damages in connection your

use of information contained in this presentation

All matters pertaining to rules and specifications herein are made subject to and are superseded by official Exchange rules. Current rules should be consulted in all cases concerning

contract specifications.

CME Group Inc. and PZH Consultants are not affiliated with Interactive Brokers LLC, or any other FINRA broker-dealer.

Copyright © 2020 PZH Consultants Pte. Ltd. All rights reserved.

Disclaimer

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Current Market Focus

3

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Financial Market Shock

Demand Shock

Supply Shock


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CME S&P E-Mini Futures (ES)

Weekly chart

The Longest Equities Bull Run in History is DEAD

23 Mar 2020 -34%

5

As of 17 Apr 2020


Financial market dislocations are circumstances in

which financial markets, operating under stressful

conditions, cease to price assets correctly on an

absolute and relative basis


A government will never default sovereign bonds

denominated in its OWN currency


Source :Bloomberg All Rights Reserved PZH Consultants Pte. Ltd


WTI vs Brent Crude Oil Spread

Shale oil boom in US &

distribution pipeline bottle

necks into Cushing

2011-2012 WTI vs Brent Price Dislocation

9

As of 01 Sep 2019


Causes of Market

Dislocation


Assumptions failed:

“A government will never default on

its own local currency bonds”


Arbitrage forces

failed to work


Crowded bubbles

burst


PICTURE

Caused by:

Assumptions breaking down

Inability for arbitrages to function

Bubbles

Small exit window – time & liquidity

Exit window is small

in terms of

time and liquidity


Causes of market dislocation

15


Monitor market dislocations to gain the edge

16

• Evidence of market pressure

• Arbitrage forces are being

(temporarily) overwhelmed

• Early warning indicators

• Confirmation indicators

• Both cause and effect of market

volatility


COVID-19 Crisis:

Market Dislocations


Bond ETFs’ Discount Against NAV



Vanguard Total Return Bond ETF Price vs NAV

Price Discount

against NAV on

12Mar 2020

% premium / discount

Daily net inflow / outflow

As of 3 Apr 2020


Cash is King… … (and USD is preferred)

The global USD funding liquidity

squeeze caused a jump in the USD

DXY index by almost 9%



USD DXY index

As of 17 Apr 2020


Funding Stress – Libor vs Overnight Repos



CME SOFR Jun 2020 vs ED Jun 2020 Futures

Funding pressures spikes as

expected Libor spread above

overnight repo stays firm

CME SOFR Jun 2020

vs ED Jun 2020 Futures

Spread

As of 08 Apr 2020


Treasuries sold off together with Equities


10 year US Treasury Yield (inverse of

price)

The usual flight to quality status of US Treasuries

(UST) was temporarily lost as the market sold UST

and UST yields spiked as the stock market continues

to tank



21

As of 09 Apr 2020




Spot Gold vs CME Gold Apr 2020 Futures

Bottlenecks in physical gold bars delivery resulted in

a big short squeeze in the gold futures market

Spot Gold vs Gold Futures Price Dislocation

22

As of 17 Apr 2020


Why is it so bad this time?

What are the causes

this time?


Trade war détente optimism

the crowded trade just got

more crowded

Source : Bloomberg


Source CNN

Funded by cheap credit,

world debt has ballooned


17Sep19 – US Overnight Repo Funding Squeeze

26

17 Sep 2019 - Overnight USD

repo rates spiked to 8.75%

Source : Bloomberg

Repo Market’s Clogged Pipes



As of 01 Dec 2019




CME 30- Day Fed Funds vs 1-Month SOFR

Sep 2020 Futures

The repo market funding squeeze was reflected in the spike

between in CME 1-month SOFR and Fed Fund Sep futures

spread prices hitting a high of 23 bps

Funding Squeeze felt in the SOFR Futures

27

As of 01 Nov 2019


Risk parity strategy

assumptions failed

Equities Bonds

Bonds

Bonds

Risk Neutral

Financial Times 20 Mar 2020


Market Stampede


Financial Markets

on Ventilator


Fed Marched to Rescue

Sources :

US Federal Reserve

12 Mar

- Extended

maturity and

scope of UST

purchases

- Term repo

increased by

$1 Tril

9 Mar

- Increased repo

offerings by $75bio

15 Mar (Sun)

- FF 100 bps cut to zero (unscheduled)

- $500 bio increase in long term UST

purchase

- $200 bio increase in agency MBS

purchase

- Provision of USD liquidity swap lines

among the 6 large global central banks

(Fed, BOC, BOE, BOJ & ECB) to

enhance the provision of global liquidity

CME S&P Micro E-Mini Futures

(MES)

17 Mar

- Established CP funding facility (CPFF)

- Established Primary Dealer Credit facility (PDCF)

18 Mar

- Established Money Market Fund Liquidity Facility (MMFL)

19 Mar

- Established swap lines with more foreign central banks

3 Mar

- FF 50bps cut (unscheduled)

23 Mar

- “QE infinity” day

- Unlimited purchase of UST and

agency MBS as required

- $30 bio Exchange Stabilization

fund (ESF) tapped

- Established Primary & Secondary

Market Corporate Credit Facilities

(PMCCF & SMCCF)

- Established Term Asset-Back

Securities Loan Facility (TALF)

- Expanded Money Market Mutual

Fund Liquidity Facility (MMLF)

- Expanded CP funding facility

(CPFF)

31 Mar

- Established UST repo

facilities for foreign and

international monetary

authorities (FIMA)

All Rights Reserved PZH Consultants


31

9 Apr

- Further 2.3 Tril to

help payroll

protection,

municipals, SMEs

and junk bonds

purchases


Source :Statista

Value of COVID-19 fiscal stimulus packages in G20 countries as percentage of GDP

32


6Apr 2020 –

CME Group Launched New Gold Futures Contract (4GC) with

Expanded Flexible Delivery in 100-ounce, 400-ounce or 1-kilo Bars

Alleviated the physical settlement issues that was caused by to the

shortage of 100-ouch gold bars

4GC Enhanced

Delivery Gold

Futures Contract




1 Year EUR USD quarterly basis

swap

EUR USD basis swaps serves as an indicator of USD funding pressure

Its move back to near parity indicates that USD funding pressures has

subsided and the Fed’s measures are taking effect

USD Funding Pressures Subsides

34

As of 17 Apr 2020


Treasuries is a Safe Haven Asset (Again) CME S&P E-Mini Futures

(ES)

10 year US Treasury Yield

(inverse of price)



The flight to quality status of US

Treasuries (UST) has returned

after the Fed’s aggressive

measures to restore market

liquidity

UST Yields now slides (price rally)

when the stock market sells off

As of 09 Apr 2020


Equities Consolidated

CME S&P E-Mini

Futures (ES)

After the announcement of QE

Infinity on the 23 Mar 2020 by the

Fed, the equities market finally

entered a phase of consolidation



This is confirmed by the

normalization of the safe

haven status of UST from

its earlier dislocation

As of 17 Apr 2020


Signs of the Next

Dislocation?


WTI Crude Oil Futures Price Crashes to Negative $40



As of 21 Apr 2020

CME WTI May vs Jun

2020 Futures

Note: May contract is NO longer the

active contract on 21 Apr 2020

Jun contract +$21

May contract ($40)


Open Interest & Volume of WTI May 2020 Contract



As of 21 Apr 2020


Source: Visual Capitalist


World Economy on

Central Banks’ Life Support


Source : Visual Capitalist


US Employment Figures Plummets



3.3m

-701k

43

?

As of 17 Apr 2020

2008 Global Financial Crisis


Source : IMF


Signs of the Next Dislocation?



As of 17 Apr 2020


P/E Ratios Back to Pre-COVID Crisis Levels or Higher!



S&P 500 Index

Current P/E

Est Forward P/E

Est Forward P/E next 12 months

As of 17 Apr 2020


Leveraging off this

understanding


Fully understand your

product specifications


Know the

market players


Remember that

markets are

interconnected





Weekly chart

Let the Market Come to You

Pick your levels and

stagger your entries

As of 17 Apr 2020




Equities Volatility Index - VIX

Utilise Volatility to Your Advantage

The market chaos has driven

equities volatility to historical highs

This is an opportunity

As of 01 Apr 2020


Selling S&P Puts to Go Long S&P Futures

The high volatility translates into

attractive put options premiums which

can improve the break-even costs for

your long S&P position’s upon exercise

Source : CME

As of 01 Apr 2020


The Market is always right…

and it is

always telling us something,

so we should listen!


www.pzhconsultants.com

www.linkedin.com/in/thomaspoh

http://www.linkedin.com/in/thomaspoh

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