DOTRADING

Current VIX Futures term structure is in backwardation.

Where are we with Oil? Investors are witnessing more controlled declines, particularly in the oil market. This is due to the demand-push economy, where fiscal policy feeds the demand and China's return to the market provides a natural underpinning. While the volatility in the market is likely to be more subdued than the jump in the past, it still presents an opportunity to investors. Over the last few years, there have been congressionally mandated sales within the Strategic Petroleum Reserve (SPR). Last year the Biden administration made an unprecedentedly large release from the SPR. As a result, the reserve is now down to about 370 million barrels, the largest drawdown in history. This has caused a lot of debate in the oil market, and there are differing opinions on what this means for the industry. While some people conflate commercial inventories and SPR, it is important to note the difference between them. Commercial inventories are a function of supply and demand in the market, whereas the SPR is a stockpile held by the government. Thus, the commercial inventory is ultimately more important than the SPR in the normal functioning of the market. Although the market might care about the SPR during a crisis, it does not matter much in a normal functioning market. Commercial storage has been rising over the past few months, and things do not look nearly as dire as some may believe. Empirically, it does not appear that the market cares much about the SPR in normal functioning. The US Administration has stated that they would purchase crude for refill in the SPR when WTI is sustainably within a range of $67 to $72. So far there has been minor change in oil prices and they have not dipped much below $70.  The current period is unique because the direction of oil seemed at least broadly on the demand side pretty known that demand was going to continue to rise, and this was an industry that was going to continue to grow and sustain itself over time. However, with all the discussion and the known urgency of the energy transition now, there's this question of who's going to invest in oil and gas supply. It's going to take hundreds of billions and trillions of dollars over the next couple of decades of continued investment in fossil fuel supplies, even as we are transitioning our economies. Historically speaking,  Saudi Arabia's approach to prices and volatility are one of the most notable price doves within OPEC, where other producers like Libya are much more keen to see higher prices in all environments. SA has massive reserves of crude, and they're worried about the price destructive elements not just of high prices but of volatility itself. If the goal is to try and elongate to the maximum level possible for Saudi State revenues the oil age, they want a reasonable price of oil, $80 to $100, and relatively low levels of volatility. The challenge with today is that with all the volatility even from the oil producer side, it only reduces the incentive to invest because no one knows where it's going to go. Additionally, we don't know how successful energy transition policies are going to be at reducing this overall level of demand. Speculative positioning in this environment can likely be used as a contra indicator. With a price floor, speculators are often the marginal or final buyer or seller of contracts and when they have a really short position it's unlikely that they will add even more shorts. In this situation, the next likely move is to go more long on a net basis, which will pull crude oil up rather than down. Conversely, when speculators are really long it's not super likely that there will be a major wave of new money coming in. These individuals are more likely to take profits resulting in falling prices.

Where Are We With Volatility? Most of the volatility observed lately has been in the yield curve and fixed income markets. This historic move is not business as usual and is changing the view on strategies and equities. Interest rates and FX vol are connected, and interest rate volatility tied to inflation. The market is convinced that this was the last hike and that cuts are coming. The US dollar index has been trending down accordingly. However, it is possible that the Fed may continue to hike rates. The market response could indicate that the Fed is losing the ability to control markets through easy money policy.  Positioning, supply, and demand are critical to understanding behavior of volatility and what happens next. The market trends across multiple time frames are a function of positioning. Dealer flow is a big component one must watch dealer positioning and trading accordingly.  Once a trend of some kind becomes entrenched, people start making money and they start doing more of it. This often leads to larger dealer positioning and its effects become more significant on supply and demand imbalances. This leads to increasingly significant imbalances in supply and demand. Market imbalances which may initially appear scary quickly become known imbalances for which investors hedge. Known imbalances dampen volatility since people are aware of them and they become discounted to the point of becoming thought of as non-issues. Investors then revert to adding to the imbalance in an attempt to make money on a trend that had been valid in the past. Generally, the imbalances resolve and prices correct only after the hedges are removed and investors think the imbalances detected were perhaps not tangible issues. Continued uncertainty within Interest rates and FX will continue to have an effect on cross-asset volatility, including equities. The Federal Reserve has a significant impact on the market and has been vocal in recent months about trying to put a cap on the market and take out speculation. The FED still has to battle a much bigger cyclical removal of credit that we have become accustomed to in remedying this inflationary impulse, but it is no longer working the way they want it to.