ION’s Chris Barnes looks back at early August’s market jitters: Just how bad were trading conditions?
Key Takeaways
- Stressful trading conditions and stressed markets are not the same
- Record OTC volumes highlighted transparency, levels of risk
- The ability to move risk in turbulence shows the market working
In a recent ION Markets ConversatION podcast, Chris Barnes, product manager at ION’s Clarus FT and an experienced OTC derivatives trader, looked back at the turbulent markets of early August in his blog, ‘Just how bad are trading conditions right now?’
Joined on the podcast by Amir Khwaja, CEO of Clarus FT, Barnes discusses the distinction between volatile and stressed markets, and the ability to move risk in these conditions.
For Barnes, there was a sense back in August that valuations were stretched, particularly in equities. Market participants were nervous and asked themselves if risk assets would continue to be supported ahead of the US presidential election in November. Couple that with the idea that trading volumes are traditionally thinner in August, and “we really had a recipe for choppy markets.”
Markets dipped sharply on 5 August, spooked by a Japanese stock sell-off, a Bank of Japan rake hike, a strengthening yen, weak US jobs data, and general economic uncertainty, before recovering. Headlines on 6 August—from Bloomberg’s ‘$6.4 Trillion Stock Wipeout’ to Reuters’ ‘Global Market Rout’—reflected the pessimism.
The correction produced a lot of interesting data about potential positioning in the yen carry trade. “We knew that there was a positioning bias for the carry trade. That was a known. What we didn’t know was the size of it. And the volumes that were reported gave us some type of insight as to how much risk was out there,” Barnes said.
It’s not like March 2023
Was the sell-off a signal that markets were on a knife-edge, in crisis? Not in Barnes’ opinion.
“We have to be very careful, I think, in terms of talking about when markets are volatile versus when markets are stressed,” he said. “There is a very, very big difference between markets being volatile and seeing big daily moves versus markets being under stressed conditions and trading in crisis mode.”
He drew a parallel with the March 2023 collapse of Silicon Valley Bank (SVB), the third biggest bank failure in the US, when fears that regional banks would fold pushed the market into ‘crisis mode trading’.
“I think the difference with the volatility we saw in August was that there was a lot of risk repositioning as opposed to a particular weakness in the markets that had been identified and which was causing contagion across everything.”
There was a lot of market movement in August, but it was ultimately healthy. “It was risk that was moving around, markets were not seizing up. Yes, it was a stressful trading environment, but conditions were not stressed.”
OTC transparency and volumes
In derivatives, because of the transparency that exists in over-the-counter (OTC) markets, there is visibility to assess whether trading conditions are volatile or stressed.
Volume is key. Are you still able to trade meaningful volumes? Are you still able to move risk around? Large market moves tend to happen when market participants are trying to move large amounts of risk, Barnes said.
Record volumes were traded on the day of the August sell-off, which was unusual for an August. An analysis of public data on swap transactions shows that 5 August recorded the highest volume ever reported to SDRs (Swap Data Repositories) for a single day.
“People were still able to move risk around, whereas during the pandemic it was a real, real stressed environment where you’re not able to move that same amount of risk,” he said.
Looking ahead
Amir Khwaja, noting that he was surprised to see that nine of the top ten days ever on swap execution facilities (SEF) happened in 2024, asked Barnes about the Fed’s rate-cutting and whether he was bullish as a trader.
“It feels like we have a solid foundation, like the central bank really has the back of the market, and that for once the market is not leading the Fed and the Fed is not leading the market, they feel in sync at the moment.”
When asked about the event risk of the US election in November, Barnes called it a “massive known known” and expects that most accounts will not be running significant risk during this time.
“We’re historically terrible at judging tail risk… everybody’s attention is away from tail risk. And that is potentially a dangerous situation to be in.”
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