Former FBI director James Comey’s gave his testimony, the U.K snap election resulted in a hung parliament and the FAANGs took a downturn, but volatility is still a no-show.
Betting on short-term volatility via exchange-traded funds has not been a winning strategy and it isn’t one today.
The iPath S&P 500 VIX Short-Term Futures ETN (VXX) and the ProShares VIX Short-Term Futures ETF (VIXY) were among the biggest flops in the ETF universe on Tuesday. The iPath fund declined 3.5% while the ProShares fund sank 3.4%.
This level of historically low volatility has not only left investors puzzled, but have invited so-called volatility tourists, noted JPMorgan‘s Marko Kolanovic in a recent note. Is this the new normal or is something else at play? Kolanovic takes a stab:
One such explanation is that the macro environment is very benign. Let’s consider that statement. In the last 20 years the VIX closed lower than 10 on a total of 11 days, and 7 of those days were in the past month. Think about that – over the past 2 decades, was the last month the most benign macro environment? (e.g. last week: Comey testimony, UK elections, ECB, geopolitical uncertainty, Qatar, FANG flash crash, etc).
Clearly that’s not it. So what else? Kolanovic thinks low correlations driven by quant fund flows as well as sector and thematic trading is one driver. Index fund flows are, apparently, another driver. That said, he doesn’t think it’ll last. He writes:
The impact of S&P 500 derivatives has been supporting the market going higher in the first few days of this week (expiry momentum), and will turn into a headwind next and the following week (reversion of expiry effect, and reversion due to monthly/quarterly rebalances). $1.3T of S&P 500 options expire on Friday, and this will change dealers’ positioning (half of the long gamma positions will expire). This can result in a modest increase of market volatility starting on Friday and into next week.
While we don’t know when the next recession will happen, every Fed hike is bringing us closer to it.
Speaking of rate hikes, the Fed is expected to raise the fed funds rate target tomorrow.