Republishing Article on Risk Off Warning - Own Convexity & SFRM5
Republishing a Note I Wrote on Wall Street Beats on May 31st
Republishing a note I wrote on Wall Street Beats on May 31st behind the paywall. If you would like to see more real time insightful analysis like this from me and my partners head over to Wall Street Beats. I promise you that you will get some good ideas and very sharp analysis from the bullpen of market veterans who have seen many cycles spanning over the previous decades.
If you look around today we are in the most volatile earnings period since 2008.
Implied Correlation is Rising Along with Downside Implied Volatility - Liquidity is Dropping Fast
The ISM report was essentially the worst report you could see with employment and activity deteriorating but prices actually rising.
Since I wrote this article June 2025 SOFR are ripping - now 90bps higher than when I bought and recommended at the end of May.
Here is what I wrote enjoy & don’t forget to check us out at Wall Street Beats (WSB LINK)
Risk Off Indicators Flashing Red: Be Aware, Own Convexity, & Long SFRM5
May 31, 2024
1.) The Carry Darling MXNJPY Has Reversed Sharply
The MXNJPY is the most crowded carry trade in the world and is one of the best risk barometers that you can monitor in global cross-asset markets today
Its off 3% in the last 3 days and is testing its first support line. Nothing too serious yet but worth monitoring
If this thing rolls consider it a warning shot that the global carrry trade is unwinding and it will transmit throughout risk markets.
2.) Complexity Completely Absent in the Market as Measured by my Fractal Dimension Model - Signalling Market Turn
Investors participating in a financial market do not all have the same time horizon, but rather heterogenous time horizons
Market liquidity is readily available when investors with many different investment horizons are all roughly active at more or less the same degree
However, market liquidity evaporates when one investment horizon starts to dominate the other time horizons. In order restore liquidity in the market, often the market may have to correct violently leading to rising volatility.
The tipping point, or turning point, of this instability can be predicted by measuring the fractal dimension of the market.
Complexity theory offers lots of clues on phase transitions and regime shifts, I built a model a long time ago to measure the presence or absence of complexity in the market and the theoretical limit of the model is 1.25, we just bounced off that to 1.31 from sitting at the limit for a week or two.
This is often a strong signal of a change of direction in markets, don’t be complacent and disregard.
3) Price of Convexity is Near Levels Only Seen in Q2'07, Jan'18, Jan'20, Dec '21
This is a proprietary model I created that is used as a proxy for risk premium in markets using various measures of convexity - implied volatility across FX, equity, credit, credit spreads, and skew of positioning.
The chart speaks for itself - be careful.
Convexity Price is at Levels only Seen Before Major Carry Crashes in the last 20 Years
4) Stocks Sit at Historic Deviation Relative to Bonds and Extremely Elevated Levels Relative to Gold
The other time periods that match this type of deviation are 1929, late 1960s, 1999/2000 Internet Bubble.
These periods marked generational tops in the stock market on a real basis as well as multi-year tops in the USD.Â
They also marked excellent spots to go long gold.
Trade Recommendations:
Own convexity in a variety of ways across FX, Credit, and Equity.
Implied risk premiums / price of convexity is at levels only seen prior to subsequent major risk off periods.
There are a variety of ways to express this feel free to inquire with me if interested in talking more about it.
Long June 2025 SOFR Futures here at 95.40.
Rates have peaked for this cycle and as growth expectations recede along with liquidity the market will begin pricing in cuts aggressively.