Volatility Bogeyman Seen Lying in Wait With Event Risk Looming

(Bloomberg) -- The decline in equity volatility from its early August highs looks overdone given the number of risk events that lie ahead, according to market participants.

Federal Reserve meeting minutes, Fed Chair Jerome Powell’s speech at Jackson Hole and a slew of economic data from purchasing managers indexes to jobless claims are among those seen to have the potential to re-ignite price swings. The Fed is seen as the most likely catalyst, with some commentators suggesting volatility is inevitable no matter what path on rates it chooses.

“Even under the best of circumstances, the ability for the markets to overreact or misinterpret Fed policy and narratives is high,” said Michael Purves, CEO of Tallbacken Capital Advisors LLC, in a note Tuesday. “This should reinforce higher volatility levels across asset classes.”

An escalation in the U.S.-China trade war and concerns about global growth sent investors rushing to haven assets earlier this month, helping the Cboe Volatility Index double to almost 25 in the week to Aug. 5. Since then, an uneasy calm has descended on markets with the gauge falling back to below the 18 level Wednesday.

Volatility Gap

Bank of America Merrill Lynch said a gap has opened up between implied and realized volatility, suggesting option markets such as those used to determine the VIX are under-pricing the likelihood of further moves in asset prices.

Volatility Bogeyman Seen Lying in Wait With Event Risk Looming

“Options are underpricing the likelihood that a body in motion will remain in motion,” strategists including Michael Youngworth wrote in a separate note Tuesday. “With the S&P reaching this high a level of realized vol, it is statistically unlikely that markets stand still going forward, especially given the numerous upcoming macro catalysts in the coming days.”

Still, while Nomura’s Charlie McElligott pointed to seasonal factors which could keep volatility high -- September historically sees on average the second-largest monthly rise in the VIX -- this year could be different. Knock-on effects from trades by a big “50-Cent”-style volatility buyer, which are said to have distorted the market recently, may help boost stocks and suppress the VIX in the near term.

Volatile 2H

Others such as Cantor Fitzgerald LP Global Chief Market Strategist Peter Cecchini are convinced more volatile times are soon to come, and with ongoing trade tensions, political turbulence from Argentina to Italy to the U.K. and non-stop tweets from President Donald Trump, it’s difficult to make the contrary case for a calmer path for markets.

“Our view remains consistent that volatility will be much higher in the second half of 2019, as has already started to manifest,” Cecchini said in a note Tuesday. “For pundits waiting for economic indicators to scream recession, it will already be far too late.”

©2019 Bloomberg L.P.

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