Head of trading: Stay alert for election volatility this summer

Published on 1 July 2024

Markets could be in store for a potentially frantic few months. While the summer period is when market activity tends to wind down, Matt Howell, head of derivatives and multi-asset trading solutions urges trading desks to remain on high alert for election volatility and headline risks, particularly following the chaotic first US presidential debate on June 27.

The head of trading says for traders to “keep their head on a swivel” this summer and advises how to approach the upcoming weeks and months.  

In this episode, he discusses interesting trends he is seeing in the derivatives space and how desks are using them to express their views. Howell also looks at the growth of credit futures and how he envisages this space to develop.

Finally, the head of trading discusses the Treasury futures basis trade, and whether it remains a popular trade in strategies in the second half of the year.

Interview Transcript

Jo Gallagher Welcome to Trader TV This Week your insight into our trading desks can prepare for the week ahead. I’m Jo Gallagher, today I’m joined by Matt Howell at T.Rowe Price to discuss the main topics and events meeting this week. Matt, welcome to the show.

Matt Howell Great to be here.

Jo Gallagher Now that we’re in the middle of summer, how would you be advising trading desks to approach the upcoming week and the next few months?

Matt Howell As far as markets are concerned, we’re not quite in full summer mode yet. A key feature of summer markets is lower levels of engagement, and typically this translates into lower volumes and tighter liquidity overall, depending on how heavy positioning is. This can either make the market very sensitive to events and create volatility, or it can mean quiet trending markets and liquidity and volatility only really returning in September. There are some signs that positioning has come down in a couple of spots. Europe, for example, has seen a lot of the long equities positioning cleared out, with some hedging strategies implemented over the last couple of weeks.

Positioning in European bond markets is likely not as big as folks think, despite events in France over the last couple of weeks. Elsewhere, positioning is concentrated and heavy, particularly in the trades that worked year-to-date. Here I’m thinking about the high-yielding areas of credit and most notably, US equities. The narrowness of the market is well-documented, and when three, six, and 12-month momentum indicators are all pointing the same way, that could set us up for some pain on a reversal. However, typically large momentum reversals don’t really come into play until after Labor Day.

In terms of what this means for trading days, I think it means the summer, same as ever traders will need to keep their heads on a swivel for any signs that volatility is returning. Given the shifts in betting markets after the US election debate, I suspect that arena could well be a driver.

Jo Gallagher What are some of the interesting trends that you’re seeing in the crypto space right now?

Matt Howell There are some really interesting structural trades that seem to be affecting markets at the moment. In the US, you’ve got zero data expiry or zero DTE options that are now quite huge, as well as an explosion of ETFs that are utilizing options. Both of these trends appear to be working mechanically to lower the overall level of the VIX.

As we know from history, lower volatility equals lower VAR, which equals the market being able to take bigger risk. Along similar lines, the dispersion trades have also been getting a lot of interest with levels of correlation in the US markets bumping along multi-year lows.

This is tied to those momentum trades that we were talking about earlier, and helps reinforce the dynamic of low index vol relative to individual names. There is a risk that that trade is getting a little bit crowded.

Finally, there’s been massive growth in banks offering quantitative investment strategy or QIS via swaps. These products really open up access to some more complex quant strategies in a relatively simple implementation. These are proving wildly successful for a number of funds, who want to get exposure to a strategy without having to build out the expensive infrastructure required to operationally support it and enables them to take what might be a tactical allocation.

Jo Gallagher It’s a big year for elections. How much impact do you see the UK, European on the US elections actually having on markets?

Matt Howell This is a record year for elections globally. So without getting into the politics, I think it’s safe to say outside central banks, these are potentially the biggest drivers of market volatility. This obviously depends on how predictable the outcomes might be.

For example, the UK election is widely perceived to be largely decided already, and hence only a really big upset would trigger any kind of market reaction. However, elsewhere, both the French election and the biggie in the US are more finely balanced and hence uncertainty over the outcome is feeding into volatility.

We can see this in Europe one month at-the-money-euro vol is bid relative to the same in sterling. In the US, we’ve looked across asset classes at what option markets are implying in terms of volatility over that November election period.

Across equities, rates and FX volatility for November 2024 is bid higher than the last six elections at the same distance from the event. Typically, we don’t see too much put on in terms of election risk prior to the summer because, as we noted, this can be quite a period and that would cost you in terms of premium decay.

However, given the level of noise surrounding that US debate, it seems highly likely that markets will be dealing with more US political headline risk than usual during the summer.

Jo Gallagher What are your views on the growth of credit futures, and how would you like to see that space develop?

Matt Howell I expect we’ll see these instruments continue to grow in terms of popularity. Futures sold nicely for a number of implementation challenges in a pretty clean way, and can make systematic implementation much easier than trading in swaps or the underlying. This is less of a challenge. In the US where you’ve got DPTF markets. But even then, futures can offer some benefits over their fully funded equivalent.

Futures are highly efficient and operationally simple portfolio construction tools in lots of other asset classes and I think you’ve done the right way. There’s no reason why it shouldn’t be the same in credit futures. Tools like this offer a straightforward implementation for macro exposures and can help reduce costs.

The key to market development is industry adoption and liquidity provision. There are signs that this is improving along the metrics that we like to look at—number of counterparties active, top of liquidity, traded volume, and open interest. Eventually, these could be as ubiquitous as equity and bond futures.  

Jo Gallagher We saw a lot of attention around the Treasury futures basis trade earlier this year. Is that still popular in trading strategies or what are you seeing there?

Matt Howell This is a topic that got lots of interest earlier on in the year from the market, but also more notably, central banks and regulators who were concerned about a concentration of risk indirectly accumulating onto banks’ balance sheets by leverage offered to the hedge funds that were participating in this trade.

One neglected aspect of that is the growth of this trade is actually a function of demand for levered duration. It’s not the hedge funds and banks that create this trade. It’s the buy side reaching for yield that creates the opportunity for hedge funds to facilitate, in part because of all the attention this trade got, we did see the size of the trade moderate a little bit over Q1, but that proved to be a relatively short-term blip.

In the last couple of months, we’ve seen a rebuild in positions that we can see on the CFTC data. That being said, although the trade is large, the data likely overstates the overall size of the trade. We’ve seen repo, which also offers a similar kind of exposure and speaks to similar kind of trends, also grow pretty dramatically over the last 18 months.

Jo Gallagher Thank you, Matt, for your insight and thank you for watching. This been Trader TV This Week.

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