From an Insider - Mood of the Market

Below is part of an email sent from a trading desk today.  Sums up the mood and feel of the market from an insiders perspective.  I highlighted some of the key takeaways and added thoughts in parentheses.

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Putting out a regular Derivatives Weekly in its standard format would seem like having the band play familiar songs as the titanic sank. Things are out of whack and there's no sense pretending it's just a dislocation or, even worse, a good entry point for trade ideas. The term "Panic of 2008" is becoming an increasingly popular description for the crisis we are currently experiencing in the financial markets (APPARENTLY THE MEDIA ISN'T THE ONLY GROUP THATS WORRIED) We decided against confronting the reader with a series of by now well-publicized charts, showing 5-standard-deviation spikes of OIS/LIBOR, swap spread, VIX equity vol, CDX credit spreads, short-dated vol etc. Instead, we offer a list of observations from the derivatives market.

*  Only those who absolutely must transact are active right now (AS WE'VE REPORTED, MUCH OF THE MARKET IS BASICALLY SHUT DOWN.  THIS SHOWS THAT MUCH OF THE ACTION IS FORCED ACTION) With the bankruptcy of Lehman Brother's Special Finance, all their client swaps have disappeared. Scrambling to replace those derivative transactions, investors are flooding broker/dealer desks with requests to price hundreds of transactions. Especially market participants who need to hedge each transaction separately (for accounting reasons) are left with no choice.

*  Relative value has left the building. Z-scores, standard deviations and other measures of dislocation are meaningless because they assume normal distribution. There is nothing normal about the current market environment and history, more than ever, is not a particularly good guide for what can be expected in the future (GOOD POINT, AND WITHOUT HISTORY AS A GUIDE TRADERS ARE NO DOUBT CONFUSED ABOUT HOW TO PROCEED.   HISTORY PROVIDES MODELS FOR HOW TO ACT IN ANY GIVEN SITUATION)

*  Each product class for itself. This is particularly true for Treasury securities, which trade in their "own space" those days (SEE MY EARLIER POST.  THE ONE THING THAT'S WORKING IS THE HAVEN OF GOVERNMENT DEBT) Correlations with and spreads to other products are close to meaningless (this includes swap spreads). Negative interest rates in Treasury space? Sure, why not?! You can't short them and rates at which market participants are able to pay fixed at (LIBOR etc.) are skyrocketing high. Looking at one product class and reaching a conclusion for another is no longer possible.

*  Serenity Now ... Insanity Later! (ENOUGH SAID!) Central banks around the world are collectively creating a huge balance sheet, like that of a giant hedge fund, and everyone gets to use a part of it. This calms down the market in the short run, but creates bigger problems to be dealt with in the future. Already do many market participants expect, as a consequence of bailouts and nationalization, soaring Treasury issuance going forward and tighter swap spreads in the future, which explains the sharp inversion of the spread of swap spread curve.