The recent price action unfolding in the Volatility Index (VIX) may be sending an early signal that Wednesday’s declines in U.S. equity indices may have followed an intermediate top, after which a prolonged period of negative consolidation could be in the offing. We increasingly refer to the essential signals emitted by major U.S. equity indices to help shape our view on overall risk appetite and the implications for a rebound in the Japanese yen and a retreat in the high yielding currencies. The Chicago Board of Trade’s VIX is viewed as a barometer of the market's attitude towards risk. A high number reflects creeping fear, with a figure above 30 possibly suggesting excessive pessimism and selling. Conversely a low VIX suggests optimism or confidence in the market, with a figure nearing 10 suggesting possible complacency.
So what can we infer from the latest price action in the VIX about the overall market, risk appetite and major currencies?
Each time the VIX has closed three or four times below 20.0, complacency may have become overstretched and a break out was imminent. Wednesday’s close of 19.73 was the fifth consecutive daily close below 20.0, but the jump from the 18.43 open suggests rising momentum for a recovery ahead.
The last time the VIX closed below 20.0 for three consecutive days was on Dec. 21, 24 and 26 of last year, after which the index soared by more than 6 points to 26.0 in the following two weeks, accompanied by sharp selling in equities.
The last occasion prior to the aforementioned one the VIX closed below 20.0 for four consecutive days was on October 5, 8, 9 and 10th. Notably, Oct. 11th marked the all time high in the S&P500 and the Dow Jones Industrials Index, after which the bear market in equities unfolded.
Thus, even though the VIX closed below 20.0 during the last five days (May 1, 2, 5, 6 and 7), the fifth day involved a rally of more than 7%, reflecting an attempt for an impending upward break out, which is bearish for equities and risk appetite.
Each of the S&P500, Dow and Nasdaq fell short of breaching their 200-day moving average, suggesting a clear failure to undo the prevailing downtrend.
The timing of this suggested top in equities also coincides with the near end of U.S. corporate season, a phase which started with mostly negative news on the banking front, followed by better performance in the technology, consumer staples and materials and energy sectors, each of which were propped by the common denominator of a weak dollar and superior demand from abroad. Once the earnings season is concluded, stocks may find difficulty maintaining their upward tone at a time when the Fed is “attempting” to signal a pause in interest rate relief, while economic data remain mostly downbeat.
The price action in high yielding currencies is also in synch with falling risk appetite. Last night’s job figures from New Zealand showed the fastest decrease in employment in nearly 20 years when Q1 employment fell by 29,000, or 1.3%, reversing the 0.9% gain in Q4. On Tuesday, Alan Bollard, head of the Reserve Bank of New Zealand said the Kiwi was “broadly overvalued”. Although such comments sound too explicit for a central banker, Mr. Bollard has shown similar extreme candor vis-à-vis the currency over the past 3 years as the high yielding Kiwi soared to multi-decade highs. The jobs data and the negative comments from Bollard do herald further declines in the Kiwi which are “classic carry trade unwinding.”
Ashraf Laidi
Chief FX Strategist
CMC Markets US
a.laidi@cmcmarkets.com
