Daily Agenda: Traders Anticipate Dovish ECB

Bonds rally in advance of policy statement; HP to spinoff its software business; Malone’s Liberty takes Formula One.

In advance of the monetary policy statement by the European Central Bank, bonds rallied across the common-currency zone with the Spanish ten-year hitting a record low yield as traders wagered that ECB President Mario Draghi and his team will continue their dovish bias. Although rates remained unchanged, as expected, sluggish inflation and lingering Brexit concerns left many market observers looking for signals that the ECB will extend its massive asset-purchase facility. After the Nasdaq Composite and S&P Mid Cap indices reached record highs yesterday and U.S. Treasuries remained relatively flat on low volume, it appears that investors in the primary developed markets—starved of any new information—appear content to stay the course as autumn looms.

HP to spins off software division. On Thursday. Hewlett Packard Enterprise announced that a long-rumored spinoff of the company’s software unit had been finalized. The transaction, which will be in partnership with Micro Focus, will result in a slight majority ownership as well as a $2.5 billion cash payout to HP. The move resembles HP’s spinoff of its consulting division into a partially owned subsidiary earlier this year.

Chinese Trade data bests expectations. August trade data from China’s General Administration of Customs today was more robust than consensus economist forecasts, with a slightly lower trade balance of $52 billion. Exports declined by 2.8 percent on an annual basis while import rose by 1.5 percent versus August of last year, the first year-over-year improvement in inbound shipments in nearly two years. Separately, pollution concerns have caused officials in Tangshan to suspend steel production for two weeks, the latest so-called capacity curb in recent months.

Malone controls Formula One. John Malone’s Liberty Media Corp. announced the acquisition of car-racing circuit Formula One on Thursday for $4.4 billion in a structured transaction expected to be completed by 2017. Investors, including CVC Capital Partners, will continue to be majority shareholders but will relinquish voting control over the racing franchise that began in 1946 to Liberty.

Portfolio Perspective: Option Markets Signal Little Fear for Fall

It is no surprise that typically the fall is seasonally the most volatile period of the year. Since inception, spot VIX has tended to peak for the year in mid-October. Known catalysts are rarely the trigger for shocks but there are a number of them ahead.

Before the end of September, there will be an Federal Open Market Committee meeting, an informal get-together of the Organization of Petroleum Exporting Countries and the first presidential debate. Expectations for a rate hike have dwindled to 22 percent following the weak August employment report, OPEC members appear to be moving toward a possible agreement on stabilizing crude markets and Hillary Clinton seems to be maintaining the advantage she has held for most of the past year. What could possibly go wrong?

A response from the options market would likely be “very little.” Standard & Poor’s 500 index (SPX, 2186.15) 1-year/3-month term structure is near its steepest of the last several years, a level reached in September 2012 and 2014 before flattening sharply. SPY’s put/call open-interest ratio is sitting near a seven-year low and VIX futures are setting net short-exposure records with each release of the weekly CBOE data.

There are a few pockets of risk heading into the fall flagged by flat term structure (three-month implied volatility elevated to one-year) in our Cross-Asset Monitor. XLU and IYR, the two U.S. equity sector exchange-traded funds most positively correlated with the iShares 20+ Year Treasury Bond (TLT)—the U.S. Treasury Bond ETF—have the flattest relative skew. That is notable since three-month ATM IV of TLT is in the 35th percentile relative to the past year and its skew is fairly steep. We have expected TLT’s volatility surface to distort from this complacent shape given the timeline of Fed events ahead. So far, we have been either early or just wrong.

After being a bit awed by how quickly the Brexit shock unwound in late June, we expected volatility to remain low and stable into the fall. In anticipation of that period ending, two weeks ago we shifted to a moderately more defensive position, recommending collars and stock-replacement strategies to protect year-to-date gains. Even with the seasonal risk ahead, we want to be patient in pushing out broader index and VIX hedges until equity and cross-asset volatility, all of which is sitting on or near multi-month lows, begins to inflect. Wake us up when spot VIX starts flirting with 15.

Jim Strugger is a managing director and derivatives strategist for MKM Partners in Stamford, Connecticut.