Strap in for spikes in the S&P 500 index’s so-called “fear gauge” now that the Federal Reserve has flipped from being a friend to something more akin to a foe to markets as it tightens monetary policy.
That’s in essence the view from strategists at Bank of America Corp. for the Cboe Volatility Index, a gauge of implied equity swings for the S&P 500.
“High and persistent inflation is turning the Fed from a suppressor of vol and source of returns to a source of vol and suppressor of returns,” BofA strategists including Nitin Saksena and Riddhi Prasad wrote in a note. They added this kind of backdrop “skews our outlook for equities negatively.”
Cboe’s gauge, also known as the VIX, has dropped back to the mid-20s after surging past 35 in the aftermath of Russia’s invasion of Ukraine. But it remains elevated compared with historical averages.
That’s a sign of background worries over economic risks from the grinding conflict, high inflation and what’s shaping up to be one of the most aggressive Fed tightening cycles in decades to get price pressures under control. The S&P 500 is down almost 8% for the year so far.
For Stuart Kaiser, head of equity derivatives research at UBS Group AG, one metric to track is the spread between the Cboe 20+ Year Treasury Bond ETF Volatility Index -- VXTLT -- and VIX.
The gap between VXTLT and VIX is positive and rising, and Kaiser said equity returns are typically poor when that happens. Put another way, the trend of pronounced swings in Treasuries could be an ominous portent for equities.
This article was provided by Bloomberg News.