Investors Are Bracing for Spike in Market Volatility
Bets on a rise in Wall Street’s fear gauge swell to most since March 2020
By Eric Wallerstein, The Wall Street Journal, Feb. 26, 2023
Fear is creeping back into the stock market. To protect against a potential downturn, traders are scooping up hedges at the fastest clip since the onset of the Covid-19 pandemic.
More call options betting that the Cboe Volatility Index, or VIX, will rise have changed hands on an average day in February than at any time since March 2020, Cboe data shows…
Derivatives markets show the federal-funds rate rising as high as 5.39% in August, the loftiest level since the central bank began tightening last year…
One of the biggest wagers tied to the VIX is for the index to hit 75 within the next month, a level only previously seen during stock-market crashes. Another popular bet sees the VIX reaching 40 in the coming months, a level that hasn’t been breached since 2020…[end quote]
Wow, betting on a VIX of 75 is pretty extreme. VIX is part of the Control Panel. VIX coupled with the Financial Stress Index (which wasn’t mentioned by the WSJ) is my indicator of financial crisis. A major coupled signal in this combination is very rare, only seen in 2008 and 2020. VIX over 50 together with Financial Stress over 5 is a signal of true market collapse, when nobody will lend to anyone at any cost and the Fed is forced to fulfill its original mission as lender of last resort.
As all METARs know, the Federal Reserve has been tightening both short (fed funds - quickly) and long (mortgage and Treasury – very gradually) interest rates to bring high inflation down to their target of 2%. The Fed has been extremely transparent about this process for at least a year but investors simply don’t believe they will do what they say…or that they will quickly back down if the economy begins to slow.
The Fed’s preferred measure of inflation, the PCE index, came in higher than expected last week, similar to the CPI the week before. The Fed will stay on course to raise the Fed funds rate at least twice (probably more) in 2023 and will hold it at their final level for the rest of the year if not longer. The Fed is determined to make sure that inflation will not pop right back as it did in the 1970s when the Fed loosened prematurely. They are expecting “pain” in the economy. They won’t turn back if/ when a recession results.
Even so, I think the markets are getting ahead of themselves both in driving up stock and bond prices since the start of 2023 and in expecting a VIX of 75. A VIX of 30 wouldn’t surprise me at all, along with a declining stock market resembling 2022. The CAPE is still way too high and the growth stocks that drove the SPX in 2021 are popping again. They are vulnerable. A VIX of 40 would be similar to 2002 (the market low after the dot-com bubble popped) and 2010 (the European debt crisis). That’s not unlikely. I would see that as buying opportunity for stocks and hope to see it later in 2023. There’s certainly no sign of stock market revulsion yet. On the contrary, the bulls have shown optimism in early 2023.
The big question is whether the stock market decline in February 2023 is just noise that will reverse or whether it will continue lower.
The entire Treasury yield curve has risen across all maturities. The 10YT now yields almost as much a it did in October 2022. Surprisingly, junk bond spreads have been falling though their yields are quite high, putting pressure on so-called “growth” companies with balance sheets overloaded with debt but little profit.
The USD is climbing. Gold, silver, copper, oil and natgas are falling.
The Fear & Greed index is in Greed but almost down to neutral. The trade seems to be changing from risk-on to neutral based on the Risk panel.
The Atlanta Fed’s GDPNow model estimate for real GDP growth (seasonally adjusted annual rate) in the first quarter of 2023 is 2.7 percent. This is a healthy growth rate that won’t cause the Fed to pause its program of raising the Fed funds rate.
The METAR for next week is cloudy. The stock market is wavering. Traders are going through the cycle of confidence and apprehension that have repeated in 2022-2023. When they believe the Fed the market drops. When they don’t believe the Fed the market rises.
Wendy
