Investors are no longer paying as much to protect themselves from the shocks they experienced over the past month, and market indicators are showing some of the extreme trepidation is over.
Traders in the US equity and derivatives markets have been keeping a close eye on the price of futures on the Cboe Vix Index, often referred to as Wall Street’s fear gauge. Last month, on the cusp of Russia’s invasion of Ukraine, the price of March Vix futures surged above futures that expire between April and November, a sign many investors had hedged against an immediate drop in the market.
That move, called an inversion of the Vix futures curve, also suggested investors expected much higher volatility in March than further out in the future. This is a relatively unusual development as investors generally have less clarity about what will happen many months from now and are therefore paying to hedge against this future risk.
But their fears were met with sharp swings in stock, bond and commodity markets as Russian forces moved into Ukraine and investors waited for the Federal Reserve’s first rate hike since 2018. The benchmark S&P 500 index, meanwhile, fell nearly 15 percent from its peak, while the tech-heavy Nasdaq Composite fell more than 20 percent from its all-time high.
In recent days, that reversal has reversed, with the price of March Vix futures contracts falling back below those expiring later this year. Traders said this indicated some extreme concerns about how far down financial markets could tumble had dissipated.
Investors attributed this move to several factors, including the fact that many funds that had used futures and options for hedging in March closed positions and took profits from recent market declines.
Charlie McElligott, a strategist in Nomura’s derivatives trading arm, said the move means futures are no longer sending out a “panic” market signal and the fact that inversion is gone means some funds are starting to dig their toes back in dive the markets.
The accompanying sharp drop in Cboe’s Vvix Index, which measures how volatile the Vix Index is, signaled that demand to hedge tail risk had “collapsed,” he noted.
As the war in Ukraine rages on, traders said other tail risks that were difficult to hedge are no longer of such concern. Some pointed to the fact that Fed policymakers laid out their plans to raise interest rates last week, removing some uncertainty about how aggressively the Federal Reserve would tighten monetary policy.
“After the Fed, your event horizon has changed a bit,” said Peter van Dooijeweert, hedging specialist at hedge fund Man Group. “Do you think the Fed will give you any new information at the next meeting? Maybe not.”
Instead, he said inflation and employment data over the next three to 12 months would shape how the Fed responds and how markets move.
“Now I’m more worried about the next three months than I was three weeks ago when I was only worried about tomorrow,” he added.
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