Inside Markets — Volatility at YTD Lows

The CBOE Volatility Index (VIX) returns to YTD lows near 12, which should keep the momentum trade intact for the time being. The VIX measures expected equity volatility by using the midpoint in S&P 500 Index option bid/ask prices. A low VIX reflects a more narrow spread, which makes hedging long positions cheaper. When the VIX is relatively low, portfolio managers (PMs) are able to keep their long positions and buy inexpensive insurance into risk events like this week’s CPI for example. When the VIX is relatively high, the cost of portfolio insurance rises and PMs have a decision to make about reducing exposure.

Equity volatility generally falls in relatively benign macro environments and rises when the macro picture becomes more opaque. Since early November, the macro narrative has been characterized by declining rates of inflation, resilient growth and the promise of Fed rate cuts. Hotter-than-expected Q1 inflation reports threatened the benign macro narrative with the March CPI print taking the VIX up to ~19 and the SPX down ~5%. Growth data remained resilient during Q1 and Fed Chair Powell made it clear that the committee wasn’t even considering future rate hikes. Wednesday’s April CPI print reestablished a declining YoY inflation trend, which added some support to a teetering macro narrative. Unfortunately, the growth leg may be the new challenge with the US Economic Surprise Index (ESI) falling into negative territory at -23. The ESI barely crossed into negative two other times in the last year, but only for one day. Today’s reading of -23 is the eleventh consecutive negative print and the lowest level in 17 months.

The Fed has hinted at policy easing if/when labor markets weaken. The promise of Fed rate cuts is also called the ‘Fed put’ because policy easing helps limit equity market downside. The Fed’s most reliable labor market data is monthly non-farm payrolls that operate with a long lag (months). And weakening labor markets are the starting point of every recessionary feedback loop with lower real incomes leading to reduced consumption, declining corporate profits, layoffs and back again.