Managing Governmental Policy Uncertainty Risk

Of all the risks that energy traders manage, there is none more difficult than governmental policy risk, when a change in well established policies may be on the horizon. This past week traders were forced to deal this risk and will likely continue having to manage governmental policy uncertainty for the next several weeks.

The direction of US financial regulatory policy may change dramatically with new proposals voiced by President Obama on Thursday. Appearing with Paul Volcker, instead of current Secretary of the Treasury, Tim Geithner, President Obama announced he will seek restrictions on proprietary trading and impose a levy on bank wholesale funding. In and of itself the market would be able to adjust to these policy changes. The greater and more difficult risk adjustment comes into play with the man standing next to President Obama as he gave his speech.

Lots of questions arise from last Thursday's speech. Where was Tim Geithner as President Obama was speaking? Where was Ben Bernanke? Why was 82 year old Paul Volcker called out of retirement bliss to construct the new regulatory policies? Why are some Democrats now changing their votes against the renomination of Ben Bernanke? Not knowing the answers to these question, traders do what they are trained to do when sudden uncertainty arises; get ahead of the crowd and exit your long positions immediately.

If greater clarity is given that Ben Bernanke will be reappointed, the markets will likely stabilize quickly. Should more Democrats try to separate themselves from President Obama by voting no to his reconfirmation, we are likely to see equities and commodities continue to slide as traders adjust to a potential strong dollar policy with Paul Volcker receiving greater prominence in the Obama administration.

The most conservative risk management tool in this type of political uncertainty is to stay flat on your trading until clarity appears. Energy traders wanting to gain an advantage before clarity is apparent should monitor the DailyFX Carry Trade Index. The index has reversed from 2009 channel highs and now sits poised to break channel support. Should this event occur, it is a clear sign traders are making a trend shift away from the year old arbitrage; sell the US dollar buy commodities. Exiting these positions requires they buy back the US dollar, which will increase downward momentum on the DailyFX Carry Trade Index. This will create more fear in the market and pressure the energy complex lower.