Know your non-linear VIX behavior

 

This simple chart provides the rules of thumb when thinking about the VIX. The VIX and stock index returns aren’t linearly related, but they show clear non-linearities and breakpoints that investors should know. If the VIX is at extremely high levels, you should buy a return to normality. If the VIX is at extreme lows, it is time to cut positions.

One key issue is that the VIX is not normally distributed; it has a high positive skew. It is more likely that the VIX will stay below 20, with only a few large moves that push it above 40, so it is critical to be ready for extremes.

Druckenmiller - Vigilante or truth-sayer?

I have spent five decades trading on a simple premise: Markets aggregate information no committee possesses, and prices are how that information reaches decision-makers. The long-term Treasury yield is the most important price in the world. It is also the only fiscal disciplinarian the U.S. has left. 

Every basis point of artificial yield suppression is a subsidy to procrastination. Suppressed long rates sugarcoat the interest-cost projections, shrink the apparent urgency, and let incumbents assure voters the debt is someone else’s problem. 

Stan Druckenmiller WSJ opinion piece 

Stan Druckenmiller had a few choice words for Treasury Secretary Bessent's changing buyback plan. The objective of the Bessent plan is not just to provide liquidity to the long end of the yield curve, but to try to bend long-term yields back to lower levels through buybacks that support bond prices. This is an attempt to stop the flood with a bucket. The fundamental problem is the size of government debt, and there is no solution. 

The first quote is spoken like any true trend-followers: market prices aggregate and disseminate information. This is foundational to any market signaling, 

The second quote focuses on the problem: the government just wants to lower the cost of the problem.

Treasury buybacks - what does it mean?

 

Treasury Secretary Bessent announced a Treasury buyback program, an increase in an existing program, amid much market discussion about its objectives and what it means. Investors should note that this does not change the size of the deficit or the Treasuries outstanding. It may change the debt’s composition and will affect the spread between on-the-run and off-the-run bonds. For the Treasury market to function well, off-the-run bonds need strong liquidity, and this should be the main focus of this program.

We are concerned with the plumbing of the Treasury market. Primary dealer capital is constrained under current bank regulation, so dealer capital is out of balance relative to trading and outstanding debt. Dealers must maintain high leverage, and if capital is insufficient, their ability to maintain orderly markets is compromised. 

The unstated and overlooked issue is the potential problems in the plumbing of the Treasury market. Actions are being taken to constrain the potential for a liquidity crisis. The chief bond salesman - the Treasury secretary - is not going to talk about this issue.

Treasury buybacks - A history

The Treasury announced an increase in its Treasury buyback program from $2 to $4 billion per operation. This is not the first time buybacks have been used to support the Treasury market, yet this action suggests plumbing problems in the Treasury market. Past buybacks have focused on ensuring more Treasury market liquidity. We expect the same for this program, but it also means the Treasury will be an active liquidity provider in the Treasury market.