VIX At 2-Month High: Fears Mount As Markets Re-Assess Rate Cut Premium

Equity markets are having a bumpy ride so far in 2024, and Tuesday was the worst day yet, with weaker sentiment underlined on Wednesday by a move on Wall Street’s “fear gauge” to a two-month high.

The CBOE VIX volatility index jumped 4.8% to 14.5 on Wednesday ahead of the market open. The ProShares VIX Mid-Term Futures ETF VIXM, an exchange traded fund that attempts to mirror the performance of the volatility index, was up 2.4% on Wednesday at 16.39.

While 14.5 isn’t historically high, it is significant in being the highest reading since Nov. 14, 2023, when the index was dropping sharply from levels above 20.

A VIX above 20 is seen as a level indicating “fearful” market conditions, marked by volatility and downside pressure on equities.

When the VIX was last above 20 on Oct. 30, it was at the start of a sharp two-month downturn that coincided with strong gains on global equity markets. As the VIX tumbled from around 21 in late October to around 12 in December, the S&P 500 index put on 16%, as did the main ETF that tracks it — the SPDR S&P 500 ETF Trust SPY.

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Rate Expectations Too Optimistic

The recent increase in the VIX may be partly influenced by one of several factors, including changing expectations around Federal Reserve interest rates.

While markets have been pricing in six quarter-point rate cuts for 2024, economic fundamentals have been telling the Fed a different story. The evidence is stacking up against market expectations, and their hopes are now looking overpriced.

Inflation data last week showing an unexpectedly sharp tick higher in the annual headline consumer price inflation rate was the first spoiler for forecasts of a Fed rate cut in March.

Then, on Tuesday, Fed board member Christopher Waller undermined hopes further when he said: “With economic activity and labor markets in good shape and inflation coming down gradually to 2 percent, I see no reason to move as quickly or cut as rapidly as in the past.”

Are Markets Re-Pricing Rate Cuts?

This, added to similar comments from fellow board members Loretta Mester and Michelle Bowman, last week, appeared to be the final catalyst needed to push the markets into a different way of thinking.

“For weeks, various Fed speakers have lining up to push back against market expectations for aggressive Fed rate cuts this year,” said Jane Foley, senior FX strategist at Rabobank.

She added: “Few forecasters see risk that the Fed may be pushed into hiking rates again this cycle. That said, no policymaker wants to be charged with having made a policy mistake. This alone is a powerful reason for expecting the FOMC to err on the side of caution over rate cuts.”

Another reason for keeping rates where they are for the time being is that few economists now believe the U.S. economy is recession bound this year. Most believe a soft landing is the most likely scenario, while some think the economy won’t land at all — that it will maintain growth throughout 2024.

Mis-Priced Geopolitical Tensions?

One further thing to note on the “fear gauge” is that geopolitical tensions should not be ignored.

Thus far, with two major conflicts — Russia/Ukraine and Israel/Hamas — happening simultaneously, markets still managed to notch up significant gains in the last two months of 2023. This may not continue to be the case — certainly as the stakes seem to be being raised in the Middle East.

Several of the spikes above 20 on the VIX in the past 30 years have been due to global conflict. But thus far, the turmoil in the Middle East has had little impact on oil prices, while investors have not been seeking the safety of traditional haven investments such as gold or Treasuries.

Gold was down 0.1% in early trade on Wednesday, while the SPDR Gold Shares ETF GLD was flat in pre-market trading. Treasury yields were higher, indicating that prices were falling.

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