Last week, BofA Merrill Lynch interest rate strategist Ruslan Bikbov recommended clients take advantage of the quiet in markets by selling gamma (i.e., shorting volatility).
The argument was that the fiscal crisis in Washington, D.C. was actually causing market volatility to decline because it was ensuring that the Federal Reserve would hold off on beginning to taper back its quantitative easing program until 2014.
But that was a week ago, and there's been very little progress in Washington. Now, Bikbov is no longer recommending clients sell gamma, "as risk-reward from selling vol no longer looks attractive with the October 17 debt ceiling deadline approaching."
In a note to clients, he writes:
We expect the market to become increasingly anxious as the deadline nears. To be sure, if the debt ceiling is not raised before the deadline passes, it will not lead to an immediate default, as the government should still have about $127bn of payment capacity on that day and we expect the Treasury will continue to meet its obligations until at least November 1. But knowing this, key players in the negotiations may view not reaching a deal before the deadline passes as an acceptable option.
However, the risk of a missed payment on Treasury obligations should increase dramatically after October 17 given uncertainty about government revenues. So we expect a large-scale risk-off market move if the deadline passes without a resolution. On the other hand, reaching a deal in time could lead to a relief market selloff, which may also bring volatilities higher.
Deutsche Bank chief U.S. equity strategist David Bianco says the S&P 500 either falls to 1650 or climbs to 1725 in a "high stakes week ahead." Read more here »
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