Thursday, July 31, 2014

VIX Heats Up as Plosser's Dissent Marks Rising Uncertainty

I am hearing...VIX Nov 21-30 call spread paid up to .70 in 88,000 earlier even before half of the current fall in the S&P Index happened.  This index has jumped 1.7 today or nearly 12% from yesterday’s close. The recent high from July 17th is nearby at 15.38.  There had been some bullish developments since historic lows were recently reached (see chart) including two bullish inverted hammers and a bullish window opened.  We should therefore not be terribly surprised by the jump on Volatility.    

There is room for greater volatility still as the Fed has come to a point where the direction of policy is not as clear.  The subtle upgrades to economic performance and labor market language in the FOMC statement yesterday as well as mild improvement to the classification for inflation conditions possibly marks a turn toward a more speedy exit from excessive accommodation than had previously been considered by many. 

Additionally, Philadelphia Fed President Charles Plosser dissented from the vote yesterday because, in his own words, ‘the guidance indicating that it likely will be appropriate to maintain the current target range for the federal funds rate for “a considerable time after the asset purchase program ends,” because such language is time dependent and does not reflect the considerable economic progress that has been made toward the Committee’s goals.’

His objection to the time variant, whether there is one currently in place for the policy rate or not, diminishes the ‘visibility’ provided by the Fed’s transparency.  No longer can we expect that all of the FOMC voting members believe that a ‘considerable period’ is an appropriate waiting period following the completion of the asset purchase program (expected to end in October) before beginning a lift-off of the policy rate.  Whether or not the data going forward provides continued evidence of strong economic growth, the variability of the prospects for the timing of the lift-off has become greater.   With that lack of certainty in monetary policy, one of the few certainties economic agents have been hanging on to, the chance for more volatility in markets, economic variables and economic performance is heightened.  

As indicated in my FOMC report; ‘To the extent economic agents have become accustomed to knowing with relative certainty an exaggerated period of forthcoming monetary policy intent, there is a decided likelihood that volatility in both economic variables and performance could increase.’ And, ‘Because of waning value in the guidance for tapering, projected to expire in October and the lack of any meaningful replacement in policy guidance, there is room for volatility, currently near historic lows, to become more elevated.’ 

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