The VIX Just Got Weird

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The VIX Just Got Weird

Two points to cover today:

#1: Fed Funds Futures continue to back off their oddball prediction for negative interest rates, a move confirmed by Treasury price action:

  • Futures prices now look entirely normal through year end 2020, with December contracts implying Fed Funds of 3 basis points versus today’s actual rate of 5 basis points.
  • The June/July 2021 contracts, which on Friday morning were pricing in negative 6-7 basis points at those expirations, closed today at 100.000/100.01. That means the odds of negative rates has declined from 26% to essentially zero.
  • Two-year Treasury yields have risen from 0.11% on Friday morning to 0.18% today, which is a step in the right no-negative-rates direction but are still below the 0.20% level of May 1st.
  • Five-year Treasury yields have also perked up, closing today at 0.36% versus Friday morning’s 0.28% low. Like 2-years, however, yields are still below May 1st ‘s levels of 0.37%.

Takeaway: this takes some pressure off Chair Powell ahead of his Wednesday morning Peterson Institute discussion on the US economy and, at the margin, is good for US equities. As we outlined last week, negative interest rates would be quite disruptive to US money markets and feel very much like a policy of last resort.

#2: The VIX is doing something it almost never does; here’s what it says about the next 1-3 months for the S&P 500:

  • The CBOE VIX Index, which measures the demand for near-dated downside protection on the S&P 500, is down 58% over the last 30 trading sessions. It closed at 65.5 on March 27th and 27.57 today.
  • A 30-day decline in the VIX of 50% or greater is extremely unusual; it has only happened 15 times since the start of the modern VIX in January 1990.
  • Eight of those occurrences (53% of the total) are in the last three weeks.
  • Here are the other instances, and where the S&P traded in 1 month/3 months after those outsized deltas:

    August 8th, 2016: next month: +0.02%, next 3 months: -1.9%

    February 7th, 2019: +1.6%, +6.6%

    October 6th, 2015: +6.0%, +0.5%

    January 6th, 2009: -7.0%, -10.6%

    November 26th, 2014: +0.8%, +1.8%

    March 20th, 2018: -1.7%, +1.9%

    August 9th, 2016: -2.4%, -0.8%
  • The average S&P 500 1-month and 3-month returns of those non-2020 “down +50% VIX” occurrences: -0.4 across both timeframes. However, if you exclude 2009 the averages for the remaining 6 occurrences are +0.7% over the following month and +1.4% over the next 3 months.

Takeaway: a rapid decline in the VIX, such as what’s just occurred, typically portends further modest gains for the S&P 500 over the next one month (+0.7%) and three months (+1.4%).

The outlier we exclude – 2009 – is, however, worth noting and we’ll close out with an explanation about why it doesn’t concern us. The date of that 50% drop was January 6th. Options prices around calendar year ends typically undervalue volatility because the last 2 weeks of any year are usually very quiet, and the VIX is the Implied Volatility imbedded in options tied to S&P 500 Futures. It takes a few days for options prices to reset once the calendar turns, so the January 6th, 2009 print was an anomaly in our book.