Volatility works both ways

More exaggerated movements occurred in overnight trade. What strikes me as more interesting is what triggered it. 

US Traders
Source: Bloomberg

In market conditions like what we’re currently experiencing, it is important to remember that implied volatility is going to move markets a lot harder and faster than normalised trade. The Chicago Board Options Exchange (CBOE) VIX is at 30.32, even after last night’s rally, showing that wild swings are still very likely and that volatility works both ways.

So what was the trigger?

Hike hysteria

Since the release of the Fed minutes at 4am AEST on 20 August, the S&P has been in free fall, moving from 2103 to the low of 1833 in five trading days – that’s a 12.8% move.

In hindsight, the key issue around the minutes is the difference between these two statements:

  • ‘Most members judged that the conditions for policy firming had not yet been achieved, but they noted that conditions were approaching that point”.

And:

  • ‘Almost all’ members need more ‘evidence’ before feeling ‘reasonably confident’ that inflation would return to the Committee’s longer-run objective.

This has clearly caused fear around the trajectory of the US economy. On one hand, employment is strong enough to lift rates, yet inflation is stagnate at 0.1%. However, at the time Fed members were saying publicly conditions were ‘gaining momentum’ for the ‘normalisation of policy’. Emerging market growth risk is a factor, but US markets are more likely to move on US data.

However, hike hysteria was put back in its box after New York Fed President Bill Dudley’s comments, ‘At this moment, the decision to begin the normalization process at the September Federal Open Market Committee (FOMC) meeting seems less compelling to me than it was a few weeks ago…let’s see how the data unfolds before we make any statements about exactly when that might occur.”

Click to enlarge - the S&P over the past three weeks

I still see hike hysteria as being a major disruptor to normalised trading conditions. I would expect to see wild trading conditions leading into each FOMC meeting now until the end of the year, or at least until they move on the lift-off scenario.

The other fear: Fear of missing out

As I mentioned yesterday, there is a very compelling case to buy this market, and I can similarly make a compelling case to sell it. This is due to the EM risks and the fact that Asia is still being sold off.

If the futures market’s indications do indeed see the ASX adding 1.2% today, then the ASX is on the verge of adding 6.2% since Monday’s intraday low.

This is a huge inflection point. We see a ‘fear of missing out’ pill in as the banks and domestic industrials ratchet back up, or will the fear cause a market roll over? The fundamentals are completing not denying it, as is volatility.

Ahead of the open, we are calling the ASX up 75 points to 5248. This would suggest fear of missing out may indeed be the winner in the interim.

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