We’ve died and gone to volatility heaven

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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.

Good morning. Yesterday, OpenAI confidentially filed for an IPO valued at more than $1tn, joining SpaceX and Anthropic (which also filed to go public last week) in targeting 13-figure valuations. SpaceX’s public debut this Friday will give us the first glimpse of how the market will absorb the huge listings. Are the biggest winners going to be the investors, or the investment bankers? Email us: [email protected] 

Today, I write about the recent market volatility, and Daire takes on stablecoins.

A perfect set-up for volatility

“Wall Street rebounds as traders race back to chip stocks” was the FT headline about yesterday’s stock market action. “Rebound” may be a hair too strong. Yes, the Big Tech stocks that got crushed after the jobs report and ensuing bond rout on Friday did well on Monday. But the magnitudes were different. Consider S&P 500 sector performance:

Friday (dark blue) was very bad for the tech cluster (information technology and consumer discretionary) and cyclicals, and good for the classic defensives and real estate. Monday (light blue) was OK for the AI cluster but weak for everything else. And Monday’s rebound weakened as they went on.

The net effect: if you zoom out only as far as the past week, there is a clear downward trend. Here is the S&P 500 and the Philly semiconductor index, which has been leading the market: 

The S&P 500 now sits at the same level as a month ago. The straight-to-the-moon momentum has been broken. Does this mean that the top is in and the rally is over? No. As readers of Benoit Mandelbrot know, when a market breaks its trend, it does not mean a reversal is coming. Instead, it means that more or less any damn thing can happen, until a new trend develops. That is one reason we are set up for high volatility in the weeks to come. But it is hardly the only one. Others:

A bond market that does not know what to expect from the Fed. As we and others have written, a combination of above-target inflation and what looks like a resurgent job creation makes rate increases a possibility. But at the same time, real wages are flatlining, rent inflation is subdued and the unemployment rate is stable. So maybe a hold is more likely? This uncertainty has driven up volatility at the short end of the yield curve, as Ed Al-Hussainy of Columbia Threadneedle pointed out to us. And when short rates get volatile, stocks follow.

The undeniable promise and irreducible uncertainty of the AI trade. We all agree that AI is a technological revolution, and that someone is going to make a lot of money from it at some point. But no one knows exactly who, or when. Maybe the barriers to entry will be low and the public will reap the benefits, while the model builders and data centre builders earn mediocre returns on their vast investments. Or maybe it’s a winner-take-all market. The fact that demand for tokens and revenues at Anthropic are both rising fast is not decisive — things will change. This means investors will be jumpy, especially considering that . . . 

A narrow market, in which everything is increasingly leveraged to tech and AI. Two snapshots give a flavour of this. One comes from Parag Thatte and his team at Deutsche Bank, who use options market data, fund flows, short sales, active fund return correlations and analyst targets to track investor exposure to equities. Right now, overall equity exposure is on the high end of normal, but tech exposure is extreme (the units here are standard deviations):

On a downright chilling note, Charlie McElligott of Nomura offers this chart of the growth in assets in leveraged ETFs linked to the Korean and Taiwanese markets — that is, to semiconductors and memory chips. If this is at all indicative of the use of leverage in AI trades, then self-reinforcing cycles of selling and buying are going to whip the market around:

All this, when secondary offerings from Google and SpaceX are adding both excitement and supply to the equity market? And with other IPOs to come? We don’t know which direction the market is going to go. But we are confident it is going to get there on a road full of switchbacks and take the corners at speed.

(Armstrong)

Non-dollar stablecoins don’t matter

The US dollar utterly dominates the market for stablecoins. More than 99 per cent of the $320bn of stablecoins in circulation are denominated in US dollars. The euro is a very distant second, with about $650mn of stablecoins pegged to the single currency. The pound is barely worth talking about. In stablecoins, as in analogue money, the benefits accrue to the hegemon.

The growth of the US stablecoin industry since the passage of the Genius Act last year has sparked a minor bout of stablecoin envy in the Old World. EU and UK regulators have been fretting about whether they’re doing enough to foster innovation in digital assets.

For the Europeans, the issue is monetary sovereignty. Widescale adoption of foreign currency stablecoins would be dollarisation through the back door and weaken the central bank’s ability to control inflation. “The growing use of stablecoins may further cement the international dominance of the dollar,” the European Central Bank’s Isabel Schnabel said last week, as if that wasn’t an explicit goal of the Trump administration’s regulatory approach.

The Bank of England, on the other hand, has tied itself in knots trying to decide whether stablecoins are friend or foe. Its draft regulatory framework is expected this month, after four years in development and a mild dressing down by a House of Lords report. But if there was demand for a sterling-denominated stablecoin in any material size, it would exist already.

For stablecoin regulation, the only real remaining question is whether the coins are allowed to pay interest, which would obviously increase demand. The risk is this would undermine (or rather replicate with less regulation) the business model of traditional banks, which is why they’ve lobbied so hard to stop it. On this, as with everything else in this space, if the EU and UK want to compete, it will be as rule-takers rather than makers.

But is this such a loss? The promise of stablecoins is that they will make payments faster and cheaper. So far, pretty much the only people who care are the crypto traders and money launderers whose transactions have been the primary use case. For the ECB and BoE, that shouldn’t be an important market. They should focus instead on fostering the development of the underlying technology and leave the currency contest to Washington.

(MacFadden)

One good read

Heightism.

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