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Perhaps some Deutsche Bank analysts have been into the absinthe.
From a DB research note out Monday:
Philosophically one has to question whether there is any merit in being worried about anything.
Well, we’re worried about the direction of this note, for one thing.
This may sound rather disappointing to inflation and growth worriers alike. It might appear a relief to policymakers but really it is what it is. There is an inherent fallacy in trying to hedge "black swan" events. Of course this assumes a certain level of competence on the part of policymakers — knowing what they don't know is a prerequisite for sound policy.
Phew, this is sensible advice — the black swan metaphor is both overused and wrongly used.
Uncertainty and risk are not synonymous, and neither are black swans. Risk can be accurately measured, priced and hedged. Uncertainty cannot and thus calls for vigilance and epistemological modesty. (Black swans call for a stiff drink and ontological modesty.)
Just as long as DB don’t start quoting Sartre. It’s a Monday after all.
Oh no…
Sartre's philosophy of negation simply points out that we need a context for something not to exist. A crossroads where there has never been a stop sign is very different from one where there used to be stop sign, but that has since been removed. In the first instance we have nothingness, in the second non-existent.
There’s another difference: in the second there will be a gaggle of angry locals asking for the return of their stop sign from the dorm room of undergraduate philosophy students:
And so after the economic and financial crisis we are worried about slipping back into deflation or riding headlong into an inflationary abyss of old to avoid it. Yet by understanding the nature of these "tail risk" events, surely we are condemning them to near zero probability. We believe selling volatility would be the core winning investment strategy.
Our volatility strategist, Aleks Kocic talks of "unknown knowns" as the root of all true tail risk. It is what we don't know that we know that is so dangerous. We didn't know that we knew the dangers of systemic interlinkages of leverage in the financial system. As we came to know, so the crisis unravelled. As a result the outcome was an economic and financial catastrophe that markets and policymakers struggled to comprehend. Of course that leaves us with tail risk strategies that purport to be "hedges" for extreme events but really migrate towards "known unknowns".
Okay. Though if our car’s brake lines were cut and we started on a downhill slope, ignorance and, following abject horror, knowledge won’t cause the car to crash headfirst into a tree (à la Camus, incidentally). It was the fact the car couldn’t stop, and some poor driving. (Now, the intellectual basis for cars and hills may have been faulty but we’re not going there.)
We may know that unemployment should be lower, but fully don't understand why. We may know that inflation should be higher, but don't understand why. This is a world of econometric modeling, inherently mean reverting. It is a reasonable basis for hitting singles and the occasional home run. It is hardly a prescription for forecasting economic regime change1.
The end of QE2 is beginning to look a bit like a known unknown. The run up to QE2 allowed real yields to fall and breakeven inflation expectations to rise. The market asked for liquidity and the Fed delivered. Risk assets did well and bonds, finally were able to rise in yield. As we end QE2 the market is rightly nervous. Risk should come off as we navigate the unknown. But it is an unknown that we know!
This is good enough for a rally in bonds. It is not good enough for a full blown deflation scare. If deflation is going to be the outcome — and maybe inflation on the other side, it is not going to be the result of the Fed refusing to add liquidity or take it away. That should mean essentially limited downside and when the time comes, upside to yields.
So we do know! Or don’t we?
We’re confused.
And isn’t this all a tad nihilstic (which must be exhausting)?
With Gauloises-stained tongue firmly in cheek we wonder whether Sartre’s frenemy, Albert Camus, is a better model for financial existentialism. The freedom that comes from accepting absurdity and the need for individual rebellion is surely much more in keeping with a Wall St mentality than Sartrean hopeless lucidity and need for moral choices.
John McDermott and Tracy Alloway are off to sit on a bench and stare at a tree.
Liens utiles Nausea - Jean Paul Sartre The Myth of Sisyphus – Albert Camus Waiting for Godot- Samuel Beckett
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