The Moment Of Truth

These next two weeks of global central bank meetings are setting up to be the most consequential two weeks of 2024 for markets. It's clear that I'm not the only one who believes that because last week saw four out of the six highest option skew readings in 30 years of history. Skew has only been 170 or greater six times and four of those occurrences were last week. Option skew implicitly represents out of the money bets on a market crash. Meanwhile, the S&P 500 hit a new all time high last week and the VIX traded all the way down to a 12 handle. How to reconcile record skew versus a collapsed VIX? The VIX represents large scale hedging of capital whereas skew represents side bets on a market event. Therefore, the divergence means that hedge fund managers are putting their client's money at extreme risk while protecting their own money with out of the money options. Knowing full well that this one sided bet on 2025 can all turn out very badly very quickly.

Skew:

"SKEW is similar to the VIX index, but instead of measuring implied volatility based on a normal distribution, it measures an implied risk of future returns realizing outlier behavior. The index model defines such an outlier as two or more standard deviations below the mean, which would characterize a black swan event or market crash."

Taking a five day moving average of skew events > 170 looks like this on a chart. The only two other times in history >= 170 were in September of this year and mid-2021.

Writing after the CPI release this morning, current Fed rate cut expectations are at 96% for next week. Today the Bank of Canada is expected to cut rates up to .5% and tomorrow the ECB is expected to cut rates as well also potentially .5%. Meanwhile, China has been promising more monetary stimulus this week as has India. Therefore it can come as no surprise that stocks are well bid in anticipation of continued dramatic monetary easing.

Here we see the 5 day ISEE call/put ratio has hit another record this week:

The Bank of Japan remains the outlier central bank in terms of monetary policy. The ONLY major global central bank that is tightening. The seeds of this impending collision were sown over the past several years during which the BOJ was the ONLY major global central bank that didn't tighten. Therefore the Yen inevitably collapsed relative to every other currency and became the funding currency of choice for global carry trades. The collapse of the Yen however led to inevitable inflation for Japanese consumers and now the BOJ is forced to tighten while every other central bank is easing. It's a recipe for total disaster as carry traders are now trapped and totally oblivious to risk:

“The very large absolute rate differential against the yen means that it will always be seen as a funding currency...The main reason why it would not be used as a funding currency for a carry trade is because of volatility.”

The carry trade unwind over the summer erased about $6.4 trillion from global stock markets in just three weeks, and the Nikkei 225 suffered its biggest rout since 1987"

All it will take for the carry trade to unwind is volatility and this has been the least volatile period of time since the summer:

In summary, you have to be brain dead not to see it coming therefore only a miniscule number of people see it coming.

And that's fine by me.