Steep Drop On The VIX

Originally published by IG Markets

The focus of the past few days has been on implied volatility, with Volatility Index taking centre stage, with the algo’s seemingly set to buy S&P 500 futures on every tick the VIX index fell.

That is still true of the overnight US session, where the VIX fell hard into 21% (from 28%) on the open of US cash equity session and it shouldn’t surprise, therefore, to see the S&P 500 initially pushing 1.2% higher into 2727. However, from here the VIX kicked higher and equity sellers have wades back in, although US equities are now making a renewed pushing higher into the close. So understand the path of VIX index and one should have a good understanding of where equity markets are headed.

Consider, the other big headwind for markets has been a strong move lower in oil, with US crude currently sitting 2.5% lower at $61.84 and this has resulted in the S&P 500 energy sector lower by some 0.8%.

The equity bulls have seen a rising oil price as one of the central components of the elevated sentiment towards risk assets. However, that premium is coming out of the market, with Brent having easily broken below its 50-day moving average and US crude now eyeing a break of its 50 day average, currently seen at $60.94. Price has firmly moved through the 19 January pivot low at $62.85 and there are risks, given this prevailing trend, that we could be headed for a test of $60. The news flow has become progressively focused on rising US output, with new statistics showing output sitting at 10.25 million barrels a day. We also saw a fairly poor weekly DoE inventory report, with gasoline stocks increasing 3.41 million barrels and crude stocks gaining 1.895 million barrels. One has to think that the move in the US dollar is also a factor, as it is with copper, which has been smashed 3%, while we can see reasonable selling in gold, silver and more pronounced downside in platinum and palladium.

So the US dollar has found a bit of a purple patch, with the US Dollar Index (basket) reclaiming the 90- handle and moving about 1% higher from around 18:15 aedt. It feels as though there is further juice in this upside move, and I would be assessing price should we see a test of the 38.2% retracement of the move from 12 December to 25 January at 90.64, as a break above here would even suggest an acceleration to the upside. The headlines will have focused on Senate Majority Leader Mitch McConnell, who detailed a bipartisan two-year agreement to raise the budget cap by nearly $300 billion, with specific focus on defense and domestic programs. $20 billion has been set aside for infrastructure, while some focus has been on the agreements around immigration, with Nancy Pelosi seemingly the pacemaker here and the market is finding strong appreciation for the bipartisanship involved here. The story of the debt ceiling could have been a volatility event, but Congress has shown it can function and the market has rewarded Trump with a somewhat stronger US dollar.

We can look into the US bond and rates market and see a slight re-pricing of interest rate expectations for 2019, with Eurodollar futures moving up a touch to 33.5bp. More of interest has been the selling in the US Treasury market, with the 30-year Treasury moving up 5 basis points to 3.12%, and showing increasing confidence in the longer-term inflation outlook. The US 10-year Treasury has staged a move from 2.75% in European trade to currently sit at 2.84% and yield has moved faster than the bond markets pricing of future inflation, so subsequently this has resulted in ‘real’ rates at the highest level since early 2016. If rising bond yields were the trigger for a spike in volatility on Friday and Monday, then these dynamics, especially when they now result in a stronger US dollar, should keep us watching the VIX index!

The AUD/USD is certainly seen good activity from clients and sits just off session lows of $0.7817 (-1%) on the day. Some focus has been placed on the Aussie/US 10-year yield spread, which is currently just slightly negative and is in theory supportive of US dollar inflows, although this should widen to around 4bp (premium to Aussie bonds) when the Australian fixed income markets open. NZD/USD has seen an even more aggressive move, certainly provided a tailwind with the RBNZ meeting pushing back its view on when the bank expect to reach its 2% target out to Q3 2020 (from Q2 2018), although surprisingly they haven’t altered its projection on the future cash rate.

EUR/USD is also traded heavy and has been the key contributor behind the moves in the US dollar basket and a move into $1.2200 seems more and more likely. GBP/USD sits at $1.3879 and should get some focus in the session ahead with so-called “Super-Thursday” in play.

Turning to Asian equities and if the 2.5% fall in the iShares MSCI Emerging Markets (NYSE:EEM) ETF is any indication then the confidence may be lacking. That said, we are seeing the Nikkei opening up with strength and our call sits above 22,000 and good gains also seen in the Hang Seng and H-Shares. Our opening call for the S&P/ASX 200 sits up a touch at 5890, with BHP Billiton's (AX:BHP) ADR indicating a soggy start (-0.2%), so one suspects the banks will put in a few points on the open , while Rio Tinto (AX:RIO) should open on a slightly stronger footing, outperforming BHP after fairly solid results. National Australia Bank (AX:NAB) has released sales numbers and analysts will extrapolate how they read into its half-yearly numbers.