Volatility Suppression Challenged

rough-seasSince the BREXIT rebound/rip, it’s been an exceptionally stable summer. Few predicted that the unexpected BREXIT vote, would be an unequivocal positive to markets. The tell, quite clear after the fact, was the global rate plunge, and the US 10-year yield sinking to the 1.35% range, around the 4th of July. The perfect combination arose to send markets to all-time highs during the summer, a scary event (BREXIT) that lowered global rates, took the Fed off the table, and led to stimulus as far as the eye could see in Europe/elsewhere, all while not really impacting the US economy. As long as “lower-for-longer ” (interest rates), a BREXIT residual, remained in-play, volatility suppression reigned, and equities could grind higher. While the dynamic persisted all summer, it came undone the week after Labor Day, and in dramatic fashion with the S&P declining a cool 53 on Friday.

Complacency evaporated rather quickly. As of Thursday morning, the market flirted with all-time highs, only to pull-back 2.7% within about 30 hours. Tipping points within the bond-stock market relationship got triggered. 10-year rates above 1.60% and hawkish Fed commentary is just too much for an expensive market with no volatility priced in. Real economic activity is stagnating, and a worrisome flow of bearish corporate news and/or uninspiring earnings preannouncements during the lull in advance of 3Q earnings adds to the sense of uninspiring news flow for the market.

There will be some Fed Governor babble on Monday, and then a quiet period. It’s tough to see how volatility doesn’t elevate through the Fed meeting on Sep 20-21. There is essentially no quick fix over the next 10-days, because no data will be released to take the Fed off the table. Seems sensible to position cautiously, and watch bond markets, currency markets, and implied volatility, into the Fed meeting. Only believe a post-Fed rally if the bond market cooperates and sends rates back down to the old range.

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