Saturday, 7 March 2009

Deleveraging continues

According to William Dudley who replaced Tim Geithner as the president of the New York Federal Reserve Bank the "deleveraging" process underway in financial markets is not complete. Prior to joining the Fed, Dudley was chief economist at Goldman Sachs. He is quoted as saying that "Hedge fund redemptions have soared and hedge fund assets may fall in half from their peak of about $2 trillion."

The slow and steady unwinding of assets including equities is probably a main factor explaining the phenomenon of the "slow motion crash" which has attracted a lot of commentary. The fact that major financial intermediaries are continuing to reduce leverage through persistent unloading of long held positions in portfolios is almost certainly part of the explanation for the decline in the spikes in the VIX as well.

When leverage was considerably higher in the fall of 2008 there were more anxious sellers of assets owing to the damage being done to P&L's but as the degree of leverage is decreasing so too has some of the seller's anxiety.
But if Mr, Dudley is correct in his assessment that the hedge funds are still unwinding, we should be ready for further deterioration in equity markets while the distribution continues, and this may well occur without causing the VIX to return to the levels seen last October and November.

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