Will Credit Markets Drive VIX Higher?

A higher CBOE Volatility Index (VIX) is ahead … at least according to ZeroHedge. And we can blame the credit markets for said VIX boom:

"For the first time since August 2008, high-yield bond 'VIX' is greater than US equity 'VIX'. The 1-month implied vol of HYG has surged over 21 - its highest since October 2011. The last time credit's volatility surged above stocks like this, VIX quickly accelerated well beyond 40, pricing in the increased business risk. Furthemore (sic), just as we saw in July/August, the cost of protecting equity markets is beginning to accelerate up to the surging cost of protecting credit markets. Both credit levels and risk suggest VIX is going notably higher."

I would note a couple things:

1. It's always time for higher vol in ZeroHedge land.
2. He's not really at all alone on this one: 99.9% of pundits expect higher vol, and there's some consensus that credit players use VIX products as a hedge, so it's not a real wild theory here.

But alas, we have some caveats with this scenario, and it has nothing to do with yesterday's relief rally … or a new bull market rally, or whatever it was. Rather, there's just no particular evidence that credit markets are going to drive up vol so spectacularly.

An implosion in high-yield debt yields can certainly send us for a loop. And if stocks get bashed, volatility will certainly spike. I also believe that credit players do use VIX paper to hedge. But the credit markets don't fully explain the outsized gains in VIX futures and VIX derivatives in the past week.

Let me explain. I'm going to use SPDR Barclays High Yield Bond ETF (NYSEARCA:JNK) and iShares iBoxx $ High Yield Corporate Bond ETF (NYSEARCA:HYG) as proxies for the high-yield debt market, and the iPath S&P 500 VIX Short-Term Futures ETN (VXX) as a proxy for VIX derivatives. I looked at the correlations between the day-over-day moves in VXX and VIX to the day-over-day moves in JNK, HYG, and the SPDR S&P 500 ETF (SPY), going back to the birth of VXX in January 2009.

Both VXX and VIX do correlate a bit with the bond ETFs. They just correlate a lot more with the market itself.

That doesn't disprove the thesis that high-yield unrest drives VIX derivatives trading, especially given that credit is apparently driving stocks in general lately. But if it was, I'd expect the correlation to at least be spiking a bit. But that's not the case either. Here's a rolling 20-day correlation of HYG moves to VXX moves, as well as a rolling correlation of SPY moves to VXX moves.

I multiplied them all by negative one so higher magnitude is "higher." There has been a spike in HYG correlation recently, but it's no more noteworthy than the spike in SPY correlation. There are various other points in time where the HYG correlation looked more significant on a relative basis than it does now.

All in all, I don't doubt that credit woes are moving stocks lately. I just don't see much evidence that they're particularly significant, relative to the recent move in VIX derivatives.

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.