VIX Unusually Tame after Bernanke Statement

The taper tantrum has smoothed over for now...but keep looking ahead

   

Markets are at a very curious crossroads this summer as investors who are accustomed to taking their cues from assessments of corporate-earnings growth and credit trends instead find themselves hanging on every word and gesture of a single person: Federal Reserve Chairman Ben Bernanke.

If you look back at the extremes of volatility that we have seen in the past seven months, almost every single one of them has been a direct result of either a Bernanke pronouncement, a Federal Reserve committee meeting statement, or comments made by a Fed official at a conference or television interview.

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This is not normal, not at all. In past years, volatility has spiked as a result of a much greater variety of stimuli, ranging from corporate-earnings misses, threats of sovereign-credit defaults, wars, energy-supply kinks, election surprises and the like. These days we find ourselves almost craving something different to move markets and minds — but instead, the shadow of the Fed seems only to lengthen.

In the past 10 days, you can see in the chart that the S&P 500 Index has risen about 3% in sync with investors’ reassessment of when the central bank is likely to start backing away from its extraordinary support of markets through the asset-purchase piece of its quantitative-easing program. At the same time, volatility has fallen 11% — and fairly steadily, aside from a blip on Tuesday, July 16.

Comments from Fed Chairman Ben Bernanke seem to have soothed investors’ nerves, reversing the spike we saw in the S&P 500 Volatility Index (VIX) Tuesday. Bernanke took a more dovish tone in his testimony to the U.S. House of Representatives Wednesday, pushing the VIX back down.

This kind of super-smooth action rarely lasts for long, so I feel quite certain that we will start seeing opportunities to trade the VIX through options again very soon.

It seems that to think about what might cause volatility to spike, we need to look at the Fed’s calendar. The next meeting of the FOMC is scheduled for July 30-31.

If you think about it, guiding expectations is inherently tough. Analysts at Capital Economics note that when interpreting what central banks are saying, many people understandably rely on the media coverage or the initial market reaction — rather than going directly to the original source. Central banks have little control over the game of whispers that starts once their statements are published.

Critics will argue that the statements should be more transparent in the first place. However, as CapEcon analysts argue, there is a risk that the more information that central banks provide, the greater the opportunities for misinterpretation! Catch-22.

The Fed’s communications have attempted to address three separate issues, often simultaneously: the timescale for tapering asset purchases under QE3, the timing of the first hike in official interest rates, and the overall stance of monetary policy thereafter. Comments that apply to one issue are often misunderstood to apply to another, CapEcon analysts observe.

Providing more information could carry other risks, the analysts argue. It may simply not be possible to provide much clarity on the future evolution of monetary policy, given the uncertain outlook for the economy and the possibility of shocks. Central banks could also end up tying their hands if they do any more than set out broad principles. But there are clearly risks in providing too little information as well. The more limited the guidance that is offered, the bigger the vacuum that market participants might fill with assumptions that are completely wrong.

So it is a difficult balancing act, and it is unrealistic to expect central banks to get it right all of the time. Bottom line for now is that the market now expects the Fed to start tapering its asset purchases later this year — most likely in September, but possibly in December if appropriate.

InvestorPlace advisor Jon Markman operates the investment firm Markman Capital Insight. He also writes a daily swing trading newsletter, Trader’s Advantage, which aims to capture profits of 15% to 40% and often as much as 100% to 200% in less than 90 days. 

Professional traders and hedge funds make huge profits off volatility.  Now, Jon’s service CounterPoint Options levels the playing field with the first service geared towards helping individual traders make steady, consistent profits with the VIX.  Get more information on Trader’s Advantage and CounterPoint Options today.

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