‘All of This Creates a Vicious Feedback Loop’ Says Trader Kevin Muir, as More Selloffs Are Triggered by ‘Short Gamma’ Options Dealers
As major Wall Street indices tumbled on renewed investor anxiety around coronavirus cases spread outside Asia, a lesser-known stock market volatility gauge spiked by more than 40 percent on Monday, hitting a level not seen since the market panic of December 2018 that fed into the Fed’s subsequent pivot from a policy of interest rate hikes to cuts.
The VIX, an index that measures the volatility of the S&P500, hit 26.4 on Monday, brushing up against its red-line threshold of 30 that is linked to outsized levels of uncertainty, risk, and investor fear.
“After not being down 3% for a single day since 2018, equities are reacting to the implied impact of almost 80,000 confirmed cases of COVID-19. Quarantines. Closed borders and ports. Suspended flights and freight. To top things off, the 30-Year Treasury hit its lowest yield in history,” said Allen Sukholitsky, chief macro strategist at Xallarap Advisory, in an email to The Epoch Times.
But today’s volatility dynamic suggests U.S. stocks may be in for more than a routine rough patch. Some exotic options trading strategies have been impacted by the volatility spike, according to veteran derivatives trader Kevin Muir, driving markets to whipsaw even more wildly due to near-automated stock selloffs in what he said could spiral into a “vicious feedback loop.”
“With the decline in the stock market, we have flipped to the point where dealers are short gamma,” Muir told The Epoch Times in an email. “When short gamma, dealers need to short more stocks as they head lower which leads to a reflexive downward spiral. On top of that, as the stock market decline increases in ferocity, dealers mark the volatility of their book higher. This action results in them having to hedge even more with more sales,” he said.
“All of this creates a vicious feedback loop,” he said. “The real question is where does it stop?”
‘It’s an Economic Pandemic’
The last time the VIX measure of stock market volatility hit comparable levels was in December 2018, with the Federal Reserve scrambling to adjust its messaging about future monetary policy moves to calm panicked markets after weeks of turmoil wiped out trillions of dollars of household wealth.
In what has become known as the “Powell pivot,” the Fed first vowed to be “patient” about further interest rate hikes, putting a 3-year-old process of policy tightening on hold, which was followed a few months later by three rate cuts.
Monday’s market gyrations have spurred renewed calls for the Fed to cut rates to cushion virus-related economic blows.
“We would rather have a vaccine than a rate cut and fully recognize that monetary policy is not optimized for addressing this type of shock. But it does not follow from this that the appropriate path of policy under the shock is unchanged,” said Krishna Guha and Ernie Tedeschi of Evercore ISI in a note to clients, as cited by MarketWatch.
Cleveland Federal Reserve President Loretta Mester said at a conference Monday that the coronavirus impacts posed a “downside risk” to the economy and that “this new source of uncertainty is something [she] will be carefully monitoring.” Still, she said she opposed cutting rates.
“I would not favor that at this time,” she said, adding that “a patient approach to policy changes is appropriate unless there is a material change to the outlook.”
Diane Swonk, chief economist at Grant Thornton and Fed adviser, said in a Twitter post that a “growing consensus among economists” was that the Fed would have to cut rates by March to contain the outbreak-related fallout.
“It may not be called a health pandemic yet but it is an [economic] pandemic,” she wrote.
Growing consensus among economist I am speaking to at #nabe2020 is that the Fed will have to cut and do so soon – March – in response to COVID-19. It may not be called a health pandemic yet but it is an ecomomc pandemic.
— Diane Swonk (@DianeSwonk) February 24, 2020
Meanwhile, markets are predicting two cuts by next December’s Fed rate-setting meeting, Sukholitsky said.
“Our base case is for two cuts this year, with a higher probability of three cuts than one cut,” he added.
IMPORTANT DISCLAIMER: The political opinions that are expressed in the re-published articles from other information media are not necessarily shared by the editors of ReporteroCubano.Net. | Visit the source for more information