The stock market’s fear gauge jumped suddenly this week, with volatility returning to equities amid heightened concern the Federal Reserve may raise interest rates higher than investors had been expecting, according to DataTrek Research.
“Equity vol is back,” said Nicholas Colas, co-founder of DataTrek, in a note Wednesday. “We are back in ‘2022 mode’, where it pays to watch the VIX.”
The Cboe Volatility Index
Wall Street’s so-called fear gauge often referred to by its ticker VIX, jumped Tuesday as U.S. stocks sold off amid rising worries the Fed could become more aggressive hiking rates in an effort to tame high inflation. The VIX ended Tuesday at 22.9, up around 14% from Friday following the 3-day weekend celebrating Presidents Day in the U.S., according to FactSet data.
“What a difference a day makes,” said Colas, with the stock market’s fear gauge closing Tuesday at “its highest level since the first trading day of 2023.” For the most part, the VIX has been “very quiet” in 2023, he said.
The VIX, which measures expected volatility for the S&P 500 index
over the next 30 days, signals “trouble” when it’s consistently above 20, Colas observed in a note last month. The fear gauge was “rarely” below 20 last year, he then wrote, when the S&P 500 suffered its biggest losses since 2008.
The VIX started 2023 “looking a lot more like 2021 rather than 2022,” Colas said in the note at the time. The U.S. stock market had rallied in 2021 before tumbling last year as the Fed rapidly raised rates to bring down the highest inflation in decades.
The S&P 500 remains up so far in 2023. The index on Tuesday had its worst performance since mid-December, leaving it with a year-to-date gain of 4.1%, according to Dow Jones Market Data.
Stocks sank Tuesday as Treasury yields climbed amid fears the Fed may need to raise its benchmark rate more than the market previously anticipated to cool the economy and curb still high inflation. “Two-year Treasury yields made a new postpandemic crisis high” on Tuesday, Colas said in his note emailed Wednesday.
Two-year Treasury yields
jumped 10.8 basis points Tuesday to 4.729%, the highest rate since July 24, 2007 based on 3 p.m. Eastern time levels, according to Dow Jones Market Data. Meanwhile, the yield on the 10-year Treasury note
climbed 12.6 basis points Tuesday to 3.953% Tuesday, the highest level since Nov. 9.
“We are back in 2022’s market dynamic, where investors are increasingly concerned” the Fed may be “taking rates higher than previously expected,” said Colas, and that “inflation will linger longer than previously hoped.”
“This tells us that our old market rule of ‘buy’ when the VIX gets to 28 – 36 still applies,” he said, explaining that “the former level is 1 standard deviation from the long run mean and the latter is 2 standard deviations.” When the VIX got to those levels in 2022, “it signaled a near term buying opportunity,” wrote Colas.
While fed-funds futures reflect some chance of a half-point rate hike at the Fed’s policy meeting in March, they still show that a quarter of a percentage point is “the more likely outcome,” according to the DataTrek note.
The Fed released minutes of its last policy meeting, which concluded Feb. 1, at 2 p.m. Eastern time on Wednesday. The minutes showed some officials were worried about recent easing in financial conditions, with some noting that “could necessitate a tighter stance of monetary policy.” The next Fed meeting will be held March 21-22.
Meanwhile, the VIX on Wednesday remained above its long-run average of 20 eyed by DataTrek. The stock-market fear gauge was trading around 22 Wednesday afternoon, FactSet data show, at last check.
“Last year, it averaged a daily close of 25.6,” said Colas. “Conversely, the VIX has averaged a close of 20.0 this year, right at its long run average.”
The VIX’s jump amid the U.S. stock market’s selloff Tuesday, when the S&P 500 dropped 2%, is what Colas might expect to see.
“Mechanically, that’s what is supposed to happen,” he said. “Changes in the VIX and the S&P 500 are inversely correlated.”
U.S. stocks were trading mostly lower Wednesday afternoon following the release of the minutes from the Fed’s last meeting. The S&P 500 was down 0.1%, while the Dow Jones Industrial Average
fell 0.2% and the technology-heavy Nasdaq Composite
edged up 0.1%, according to FactSet data, at last check.