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Investors are bracing for more volatility this summer after this year’s calm in global financial markets was shattered.
A surge in the Vix index — the market’s “fear gauge” which shows how far investors expect US stocks to swing over the next month — to its highest level on Monday since the start of the coronavirus pandemic in early 2020 could herald a tougher period for global stocks and put a dampener on capital markets activity in the short term, said analysts.
“This is a regime shift,” said Ajay Rajadhyaksha, global chair of research at Barclays, who described the Vix’s peak on Monday as “pretty scary”.
“I find it very hard to believe that you’re going to go back to business as usual,” he added.
The US stock market entered second-quarter earnings season in early July in its sleepiest condition for years on some measures, with the S&P 500 making steady gains to hit record highs and a Cboe index of historic volatility at its lowest level in four years.
But investors have been woken with a jolt. Sharp falls in recent days have pushed the S&P down about 7 per cent from its peak, even after a partial rebound on Tuesday. The Vix leapt 65 per cent on Monday, its largest one-day jump in more than six years. At its intraday peak, the index was up 180 per cent, which would have been its biggest climb in at least 20 years. Trading in options tied to the Vix hit a six-year high on Friday.
Three-month implied volatility on Monday rose above one-year volatility expectations for the first time since the banking crisis of March 2023. Max Kettner, chief multi-asset strategist at HSBC, said this was a sign of the “proper panic” gripping some investors.
“People were suddenly willing to pay ridiculously high prices to protect for the short term, they didn’t care what might happen months from now, they wanted insurance now,” he said. “That’s entirely different from the mood just four or five trading sessions ago.”
Traders said higher volatility means hedge funds and other investors who very closely monitor the amount they could potentially lose are having to unwind even profitable trades to cut their risk levels. This could lead to exaggerated price moves in a wide range of assets.
“Risk teams would have been tapping traders on the shoulder saying ‘you have to unwind this trade’ even if it’s making money,” said one fixed income and currencies trader at a large European bank.
“Or if you had one trade that was losing money and another that was making money, you’d have to unwind both. That’s why you’re seeing weird moves,” the person added.
Among retail investors, visits to Vanguard’s investment platform were twice as high as the previous peak set during the mid-pandemic meme stock mania. Retail investors were “aggressive net sellers” in the market on Monday, according to research by JPMorgan, pulling more than $1.4bn out of single stocks.
“Everyone had moved to the side of the boat that said it’s all totally fine. Then people started to re-evaluate the underlying state of the economy . . . on top of buoyant markets, and that led to sharp reversals,” said Eric Veiel, chief investment officer at T Rowe Price, which has $1.5tn of assets under management.
The return of volatility could put a dampener on capital markets activity. August is traditionally a quiet time for initial public offerings, but bankers had been hoping to see some bond deals and a flurry of large stock sales and convertible bond offerings by listed companies.
“This week was lined up to be one of the busiest of the second half of the year,” said Maureen O’Connor, global head of Wells Fargo’s high-grade debt syndicate. “Only seven trades have made it to the market so far. That gives you a sense of how many more are waiting for market access.”
The market sell-off was triggered by a combination of weak economic data and disappointing corporate earnings. But as the rout gathered pace on Monday, many traders said the downturn was exacerbated by investors being forced to unwind their trades. For instance, traders who had borrowed in yen to buy higher-yielding assets had to sell those assets quickly as the Japanese currency rapidly strengthened.
Whereas in Friday’s sell-off “there wasn’t really a huge amount of panic”, the Vix’s leap above 60 was “totally divorced from fundamentals”, said Mandy Xu, head of derivatives market intelligence at Cboe.
The moves in bonds, meanwhile, show “the market is pushing very, very hard” for the US Federal Reserve to cut interest rates, said Sonal Desai, chief investment officer for fixed income at Franklin Templeton.
“If the Fed caved to what the market is demanding right now it would create a greater degree of volatility because it would seem like the Fed was worried,” she added.
There are signs that some investors expect volatility to sink again. The biggest increase in Vix options trading was in put contracts — the right to sell at a set price — mainly bets that the Vix would fall back by mid-August or mid-September.
But many traders are wary of assuming the previous period of calm will return anytime soon, when markets have reacted in such a jittery way to economic data.
“The positions [that were hit on Monday] were all really crowded,” said Veiel at T Rowe Price. “Stocks will start to look more attractive because they’ve come down in price . . . [but] it would be arrogant to predict with certainty that this is definitely the bottom.”