I like to MOVE it MOVE it

The minutes of the Federal Reserve released on Wednesday night, despite their more hawkish tone, equity and bond markets took them mostly in their stride. Treasury yields fell very modestly and the spread between the two year and ten-year yield has settled around 30 basis points. As the bond market has settled, this did appear to settle equity investors, however, Thursday saw the return to equity volatility. The US dollar rose, post the release, and gold fell in reaction to slightly higher bond yields. The price of oil fell after the release of some US inventory data, the equity market could remain as sensitive to any moves in the oil price as it is to US interest rate expectations.

The minutes of the September meeting reinforced the expectation that the Federal Reserve will continue to raise interest rates in the coming year. There appears to be a general agreement amongst members that the Fed policy should continue its move towards a neutral policy and at some stage in the future a more restrictive one. After Jerome Powell’s comments in the past week, this came as little surprise. What the market now has is some clarity on the feeling of support for this policy within the Fed.

We talk about the Vix index a lot and hopefully, those who read these articles on a regular basis understand the principle. There is always Google to fall back on, if not. In a nutshell, it is the change in cost to ensure your portfolio against future market moves using the options market. The greater the volatility the greater the premium one is charged. Black and Scholes invented the model portfolio traders use, the fundamentals of which are based on probability statistics. 

The reason it is helpful as it does give a good sense of where the mood of the market lies. For many months volatility in equity markets was low, historically low, and this reflected the Goldilocks world we traded through in the past year. In the past quarter, the Vix index rose despite a strong performance from US equities. This was a good clue that October may have surprises in store for investors. The index rose to 25 earlier in the year when we had the euphoric shakeout, the level it reached in the past week before US equity prices stabilised. The bond market has its own volatility index called the MOVE.

Another data set that is worth keeping an eye on is the St Louis Fed stress index. The index measures the degree of financial stress in the markets and is constructed from 18 weekly data series: seven interest rate series, six yield spreads and five other indicators. At the start of the year, the index rose, however despite the Fed desires to keep raising interest rates the index appears to show little indication of financial stress creeping into the US economy.

Posted on October 18, 2018 .