Treasury yields climbed on Chair Powell's inaugural Congressional testimony.
Traders and investors increasingly will need to work through the implications of a new narrative for markets and risk taking.
VIX term structure remains flat, with spot now above the futures and 10-day realized vol below.
Special Note: an important piece of news came out with ProShares' decision to reduce leverage on its UVXY and SVXY products. This will be handled in a separate article.
Market Intro
Powell: Expect further gradual rate increases from CNBC.
The Fed’s Powell gave an upbeat view on the economy that market participants considered hawkish (see below) in yesterday’s Congressional testimony.
IB: TNX – 10Yr Treasury Yield
The testimony resulted in a 7.5-basis point move in Treasury yields (IEF, TLT, AGG) from peak to trough.
The step-up in yield impacted precious metals (GLD), as the Fed is increasingly being viewed as taking the prospect of inflation as a serious matter.
Thoughts on Volatility
IB: S&P 500 Futures
Clearly, for the day, Narrative #1 took the day. That really is the key issue here: markets are working harder than they’ve had to in a very long time to determine the narrative.
The back half of 2016 and more or less the whole of 2017 really was an unlikely story of investors not worrying. That’s very different from climbing a wall of worry.
Geopolitics, Brexit, storms in the White House, smatterings of worrisome economic data, Fed balance sheet reduction, rising rates: none of it mattered. Realized volatility withered, and took down products such as VIX and its associated futures, to all-time lows.
So now, we appear to live in a different world. And what’s more important is that we haven’t lived in it long enough to know what drives markets higher or lower; but the magnitudes of moves have increased.
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Urban Carmel reminds investors that 2017 was not all smoke and mirrors. In my view, the number one factor that could keep the bull market rolling, and volatility in check, is strong earnings growth such as we saw from Macy’s (M) in its earnings release. In particular, revenue growth is key.
The Dollar also has a role to play in determining the narrative.
Even here, the relationship between the currency and stocks or bonds appears tricky – too many ways to spin the result of the story.
Compounding this is that the greenback was sold pretty heavily between May ’17 and the present. Arguably oversold. So while dollar volatility may create ripples in its own right, the larger direction carries important implications for earnings growth and global stability.
VX Term Structure
The biggest development after yesterday’s drop off in stocks came at the front end of the curve, and really even then there is little to report. That may well be the point: a >1% drop in equities was very much taken in stride. With 10-day realized vol at maybe 40% of what it was only a week or so ago, the term structure appears to have plenty of healthy room for a volatility risk premium here. The increase in spot VIX was “orderly”, to borrow a term from Mr. Powell in relation to a question about the VIX ETPs.
When trading these products, either from the long side (VXX, UVXY, TVIX) or the short side (SVXY, ZIV), it can be natural to obsess over small changes. While yesterday’s “contango” may soon give way to mild backwardation, the key here is that the futures curve is basically flat. To the degree that spot prints above the front-month (currently March), this will provide a tail wind for longs as the futures curve gradually moves toward spot. But the situation is highly fluid.
What I find most remarkable is how successfully the 10-day realized vol component was settled down. I would argue that the current multiple that stocks carry cannot remotely sustain itself with realized vols much above 16-20. In my view, today’s prices are basically predicated on low rates and low volatility deep into the future.
None of this is to say that rates cannot remain “low” (that’s actually a subjective term that deserves more context than I give it here) for a good length of time. But certainly low volatility argues for higher multiples and stocks have passed an important test by managing to just slow the pace of motion.
Conclusion
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Clearly the biggest piece of news in the vol space over the last couple days relates to ProShares’ decision to reduce the exposures on two of its products (UVXY, SVXY) to the S&P VIX Short-term Futures Index, on very short notice.
Readers have had much to say, and with good reason, in response to this action. This is enough of a story that I’ll devote another article to it soon. For now, I’ll just post the announcement for reader context:
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I actively trade the futures and options markets, potentially taking multiple positions on any given day, both long and short. I also hold a more traditional portfolio of stocks and bonds that I do not "trade". I do believe the S&P 500 is priced for poor forward-looking returns over a long timeframe, and so my trading activity centers around a negative delta for hedging purposes.
Market Volatility Bulletin: Fed's Powell Sees Upbeat Economy, VIX Picks Up https://t.co/VjEW7CeJhn— Algobit Forex (@AlgobitForex) 28 febbraio 2018
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