What It'll Take to See the Next Wave of VIX Panic

Is the Fed to blame for VIX underperformance?

Jan 26, 2016 at 7:45 AM
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I've long thought that the mega hype around all things Fed is wildly overblown. I mean, we heard about a future hike off of ZIRP for what seemed like forever. It happened and we moved on.

But, of course, we didn't really move on. World markets have gone nuts since then. Currencies moving around, commodities tanking, junk spreads popping, Patriots losing, etc. So did the Fed beget all that? Greg Ip in The Wall Street Journal says "yes" (subscription required):

"Short-term rates and short-term bond yields don't capture how much the Fed has actually tightened. Since the end of 2014 the trade-weighted dollar has risen more than 20%, spreads between yields on junk-rated bonds and Treasurys have widened three percentage points, and the S&P 500 index has dropped 7%. Even the confusion and capital flight triggered by China's devaluation carry the Fed's fingerprints. The yuan was dragged higher as the greenback, to which it was pegged, rose on expectations of Fed policy normalization. This imparted deflationary pressure that Chinese authorities found intolerable.

"While a quarter-point rise in interest rates wouldn't tip the U.S. into recession, an across-the-board tightening of financial conditions is a closer call. J.P. Morgan economist Jesse Edgerton reckons recent real economic indicators such as business sentiment and building permits imply a 21% probability of recession in the next 12 months, marginally above the 18% average of any given year. But financial indicators such as stocks and corporate bonds put the probability at between 30% and 40%."

Well, at least the Fed can ease short-term rates now! OK, I'm kidding. Sort of.

I guess this isn't really an argument that the rate hike itself did much, but rather, that the switch-flip to tightening led to all these ancillary effects. And, honestly, that makes a lot more sense than the rate hike itself doing much.

So is this all impacting our friend the CBOE Volatility Index (VIX)? Is this why VIX isn't lifting all that much? I'd have to stretch to make the connection. In fact, it almost makes the reverse argument. Volatility is clearly sloshing across asset classes. That usually washes onto Wall Street. And thus players usually react with more panic in equity options. Yet they're just not.

Perhaps we need another leg down and a violation of the recent lows? We've pretty much made a double bottom for the moment. I hope that's it, but if not, I'm guessing that's when we see the next wave of VIX panic.

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


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