A bet each way as the VIX moves higher

US traders snapped a solid two-day correction on rumours that the President may consider alternative proposals to the conditions attached to raising the debt ceiling.

- The miscommunication of the Fed

- Volatility remains as US VIX tops up

- China remains cautious of Washington talk

- Ahead of the European open

There is one major ‘if’ attached to the President’s potential olive branch, and that is reopening the government, something that still looks very unlikely in the interim as the partisan politics from both sides continues to rage.

The miscommunication of the Fed

One thing that is clear from the minutes out of the Federal Reserve overnight, which was slightly lost on the nomination of Professor Janet Yellen,  is just how the views of the Fed members are varied and how they have caused severe miscommunication within the markets.

Putting the contentious decision not to taper at the last meeting to one side, the issue that is currently before the Fed is the design of the open-ended framework of QE3.

Unlike QE1 and QE2 that were fixed in size and in time, QE3 is fluid and data dependent. The effect and measurement of asset purchases are done on efficiency and cost; this opens up the programme to interpretation.

What are the conditions that need to be met to see efficiency created? What are the appropriate costs involved to reach these levels? Data dependency design of QE3 has been the issue from conception, and as a compromise the Fed settled on using conditions in the labour market and the bulk measure.

However, this too is open to interpretation, as what constitutes a ‘substantial’ change in the labour market? No actual figure or rate has ever been agreed upon internally, which has led to external interpretation.

This is why the Fed is guilty of poor communication and why the bond yields run up heading into the last Fed meeting occurred. External doves and hawks have differing interpretations and this causes market imperfections.

It is ironic that dovish officials noted this long-term interest rate rise as consideration for not tapering, something of which the Fed was a direct cause. With Janet Yellen now rubber stamped for the helm, there is a real possibility that QE3 could have the liquidity tap on full until mid-2014, as she has publically stated unemployment needs to be lower still for her to act. This leaves more chances for misinterpretation. What is certain from the minutes is that it will be supportive for equity markets, and is the possible explanation for the pop in the S&P and the DOW despite the political impasse remaining ironclad.

Volatility remains as US VIX tops up

I will refer back to Chris Weston’s note on Tuesday October 8 which saw traders continuing to hedge positions. Yesterday the CBOE experienced its fourth busiest trading day in history and the sixth day this year, where 300,000 contracts or more were sold as the VIX index crossed the 20-point mark.

The S&P has lost 4.82% from the intraday high on September 19 to the intraday low last night; the correction in June trading as Chris alluded to was a 6% sell-off, so this correction has 1.2% to match this move.

 The offset this time around is that equity markets are holding put protection, and the news from the CBOE suggest those trades are being locked in rapidly. The crossover seen in June between the S&P and the VIX is almost complete this time around, and continued deadlock in Washington should see this cross occurring over the coming days.

I am still short the US markets until this political storm is resolved. The possibility of puts being triggered over the next seven days is high, and the closer the US lurches towards default the faster the puts will be triggered. I am still of the belief that this correction is not finished despite the fact US earnings season looks like being positive (I am watching Wells Fargo and JP Morgan as a gauge of the retail credit market tonight).

The rising in volatility has seen the flows in Asia remain subdued; both Japan and China are treading lightly with jump of 0.8% and 0.1% respectively at the time of writing. The jump in the Nikkei is expected on the inverse correction with the yen. The currency has been under sustained pressure over the past few days and is a leading indicator of the direction of the Nikkei and explains this move. Shanghai however may be watching developments between Beijing and Washington.

China remains cautious

The interconnection between Beijing and Washington is something to be aware of; approximately 35% of US debt is settled in Beijing and although tapering may now be several months off rather than several weeks, the effects on capital markets when the programme is unwound will be felt.

China may look to remove the possible ‘hard landing’ around its own debt concerns by selling out of the $3.5 trillion it has in foreign reserves.

The central government has taken several target steps to address the issue of local business and government debt by wringing out speculative lending, however another possibility it has in reverse is to provide a buffer through foreign reverse sales. This would be locally supportive and would see the targeted 7.5% GDP well supported - a net positive for the region as well.

However, Beijing is well aware of the risks this would pose to global debt markets if it was to move on its foreign reserves too soon and too fast. The gentle reminder to Washington to get its house in order was a double message for now and into the future of possible moves it may take to safe guard its economy.

Ahead of the European open

European equities look like opening in the green as the eurozone markets look to the positive leads out of the US.

The soft call for the FTSE can be attributed to the expected ‘no move’ announcement for the cash rate out of the BOE, considering the statements published in the UK press from Mark Carney that he sees no need for further stimulus given the pace of the economic recovery in the UK.

I suggest watching GBP/USD, which has priced in these comments but it is likely to remain elevated and may punch higher on a hawkish announcement. A hawkish statement would also have a negative impact on the easy money that has flown into the FTSE and may see the positive call turn red post the press conference.

French and Italian industrial production will also be in the spotlight with expectations of a positive growth read for the first time since June in France and August in Italy - a positive leaver on EUR/USD.

This information has been prepared by IG, a trading name of IG Markets Limited. In addition to the disclaimer below, the material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients. See full non-independent research disclaimer and quarterly summary.

Find articles by analysts

Een artikel zoeken

Form has failed to submit. Please contact IG directly.

  • Ik wens per e-mail informatie van IG Group bedrijven te ontvangen over handelsideeën en IG's producten en diensten.

Voor meer informatie over hoe wij uw gegevens mogelijk kunnen gebruiken, bekijkt u ons Privacy- en toegangsbeleid en onze privacy website.

CFD’s zijn complexe instrumenten en brengen vanwege het hefboomeffect een hoog risico mee van snel oplopende verliezen. 79% van de retailbeleggers lijdt verlies op de handel in CFD’s met deze aanbieder.
Het is belangrijk dat u goed begrijpt hoe CFD's werken en dat u nagaat of u zich het hoge risico op verlies kunt permitteren.
CFD’s zijn complexe instrumenten en brengen vanwege het hefboomeffect een hoog risico mee van snel oplopende verliezen.