Fed’s Actions And Lack Of Actions Fuels Financial Market Volatility

Fed’s Actions And Lack Of Actions Fuels Financial Market Volatility

$DIA, $SPY, $QQQ, $VXX

For weeks participants were on the fence as to whether the Fed pulls the trigger this week on the 1st interest rate hike in nearly a decade, Wall Street’s “smart money” was not decisive on the Key issue, volatility will be with us for a long while. As we saw in today’s seesaw market action

Headed into Thursday’s meeting on interest rates from the FOMC (Federal Open Market Committee), the Federal Reserve’s monetary policy-setting panel, speculative positions in CBOE VIX index futures (NYSEArca:VXX) were the most net Long on record.

To this crowd of hedge funds and other big speculators, it really did not  matter what the Fed does/did/or will do.

Raising rates for the 1st time since Y 2006 would have almost certainly send waves through equity markets, and not moving will keep the guessing game, and accompanying market gyrations, as we saw Thursday, will alive for weeks to come.

There is consensus in the market that the Fed meeting will continue the volatility for another 6 to 12 weeks till their next meetings in October and December.

The most recent weekly Commitments of Traders (COT) data from the Commodity Futures Trading Commission shows speculative net Long positions in VIX futures stood at 37,925 contracts as of 13 September. Not only is that a record high, it is more than 2 standard deviations from the norm.

Since VIX futures, a forward-looking gauge of market risk, were introduced in 2004, speculative positions have been skewed toward lower volatility far more often than not. Long VIX futures positions benefit from increased volatility and can be used to protect equity portfolios.

Moreover, positioning in VIX futures has flipped like never before over the last month as the Fed guessing game has been compounded by worries over the health of China’s economy and its volatile stock market.

In contrast to the latest positioning, speculators in early August were net Short by 64,445 contracts, a reversal of more than 100,000 in 5 weeks highlighting the strong conviction of hedge funds and other large speculators that market gyrations are far from over.

Volatility arrived in earnest for US stocks about 4 weeks ago as investors got rattled by a free fall in Chinese stocks and a series of unsuccessful measures by authorities there to stem the sell off.

That helped push the Standard & Poor’s 500 index into its 1st formal correction in 4 years, and the US benchmark remains about 7% off its record-high close set in May.

Unlike the many fleeting instances of volatility spikes seen in the last couple of years, the current run up has not been quick to recede.

Tuesday the VIX, which measures the cost for protective downside positions on the S&P, closed above 22 for the 17th day running, the longest above that mark in nearly 4 years. The index was last down 1.7 pts at 22.54 Tuesday.

Given the duration of the current volatility and shocks of similar magnitude in Y’s 1998, 2010, and 2011, it is unlikely that calm will return to markets very quickly.

Trading in the options market also points to caution as investors protect their positions and look to replace expiring hedges.

Another factor is that Friday is a Quad-Witching day, when options on stocks and indexes, and index and single-stock futures all expire together. The expiry of existing positions and the opening of new positions, called rolling, could make for some heavy trading later this week and add to market volatility.

Thursday afternoon’s action was seesaw active because what the Fed said in the meeting spell out to people where they need to hedge to. The Fed stood pat and acknowledged the fragile US and global economies.

Stay tuned…

HeffX-LTN

Paul Ebeling

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