On a scale unseen since the regional bank crisis in March, the US stock selloff is causing fear among volatility traders. That’s giving rise to optimism that the equity meltdown is nearing its end, according to bizarre Wall Street reasoning.
On Tuesday, when Treasury rates continued to rise and market losses accelerated, experts in derivatives priced in more volatility for the present than for the future.
The spot price moved above its three-month futures for the first time since the volatility in US lenders earlier this year as a result of a 2.2-point increase in the Cboe Volatility Index, or VIX, a measure of expected price fluctuations in the S&P 500.
In the past year, the inverted VIX curve setup has shown twice, and both times it has signaled market bottoms.
“The Treasury yield is really all that matters,” said Chris Murphy, co-head of derivative strategy at Susquehanna International Group. “However, a VIX-term structure inversion is a sign the stress is being fully priced in.” Before I’m sure this selling spree is over, I’d need to witness a VIX term inversion.
As a result of strong job statistics and worries that the Federal Reserve will keep interest rates higher for longer, the S&P 500 dropped more than 1% on Tuesday, hitting a four-month low.
“Technical levels are being breached, and downside momentum is accelerating. According to Tallbacken Capital Advisors’ founder, Michael Purves, “No one knows whether the higher rates will cause something to break. But with the rise in interest rates, it seems like the likelihood of something shattering is only increasing.
Three sessions in a row saw an increase in the VIX, which briefly topped the closely watched 20 mark before closing at a six-month high. In contrast to typical situations where investors are prepared to pay more for contracts with a longer time horizon, the volatility index also increased above its three-month futures.
At 0.2 points, the VIX’s premium over its futures was far lower than it had been during the selloff that concluded last October and the rout in March. Inversion also lasted for days and weeks in the two most recent incidents.
Nevertheless, the pattern was added to a growing list of contrarian signs that risk aversion may have peaked, paving the way for a market rebound. That’s what occurred a year ago when, after everyone had set themselves up for a recession, shares launched a strong rise, only to be caught off guard when the economy continued to grow.
Commodity trading advisors who make long and short bets in the futures market to ride the trend of asset prices are a good illustration of capitulation. The evacuation of the group, however largely driven by chart indications rather than fundamental criteria, relates to the deteriorating perception of equity markets.
Data provided by Scott Rubner of Goldman Sachs Group Inc. shows that during the past five sessions, CTAs have sold more than $40 billion worth of shares, the largest since at least 2014.
Dave Lutz, head of ETFs at Jones Trading, said, “It can get worse, but we’re approaching peak fear.”