Thursday, July 10, 2014
VIX; Don’t Bet Everyone Else Freaks-Out
The VIX Index jumped higher to open above a downward sloping trend that has lasted since late-April. Reasons for the spike in the volatility index are uncertain but could include some of the following:
· The FOMC Minutes which communicates a shift from forward guidance to a stronger reliance on unfolding economic conditions as reference for monetary policy evolution.
· Israel/Hamas rocket exchange and escalations
· Portuguese bank ‘short-term’ debt overdue repayments
· Of course, equity market weakness, either for above reasons or separately
Today action in the VIX is relatively critical for technical reasons. The spike higher leaves an open window in candlestick analysis which points to support below on unexpected news. The advance also brings the index clearly above the downward sloping channel trend which had successfully captured trade since late April. Longer standing confusion about the meaning for lower volatility will call forth the prospects for heightened reassessment for portfolio protection on the back of present move.
At open this morning the VIX index reached only as high as the 100-day moving average at 13.23. It had traded below this moving average since the aforementioned late-April trend start. The VIX will need to exceed the 100-day m.a. on settle today to invite more momentum interest.
Technically important is the single session July 3 ‘inverted hammer’ (circled green on chart) that included a low mark of 10.28, a level not seen since early 2007. The small body session at the low trade is indicative of low confidence by bearish contingent of VIX shorts. The subsequent session gap (‘bullish window’) higher leaves an important reference for support that could be signaling a longer and more serious recovery in volatility.
I have written in the past that a major driver of the low volatility today is the acceptance that global central banks, the Fed in particular, has large sway on the prospects for market performance. The belief in this ‘control’ is widespread and generally promotes less uncertainty. There is some concern that the Fed may be moving away from forward guidance and allowing monetary policy evolution to be guided more strictly by economic and financial market developments. Recognition that risk spreads have narrowed at the same time unemployment measures have fallen faster than earlier expected and inflation is starting to move higher give rise to concerns for policy adjustments.
If the Fed is telling markets that they will need to pay attention to economic developments rather than simply relying on the Fed guidance for policy moves as far as 2-3 years out, as market participants have become accustomed, there is certainly room for greater volatility. However, the Fed has come well along the communications learning-curve since the mid-2000’s and we should expect they will proved a wide and powerful collection of measures to guide market expectations for monetary policy even in a rising rate environment.
The bottom line is that we are still well away from the first policy rate move by the Fed and even further away from a Fed surprise. Unless geopolitical developments usher in considerably more risk than is currently widely believed, expectations for much higher VIX levels may be short-lived.