Lykeion Research - April '23

Volatility Indicators: Focus on MOVE over VIX

Investors have historically focused on the VIX (volatility of the S&P500) as a gauge of market sentiment. Last year’s bust in the bond market has raised the profile of the MOVE index (volatility on a range of US bond yields), but it’s still below the radar for many investors. The MOVE index should take priority for now.

Last year’s bear market in equities was remarkably well-behaved. Equity volatility, as measured by the VIX index on the S&P500, was elevated but remained relatively range bound. Interestingly, it peaked during Russia’s initial invasion of Ukraine, well before the ultimate lows in equities.

Last year was a professionals’ bear market. Asset managers were (and still are) running high levels of cash in anticipation of the redemptions which traditionally stem from a recession and that, so far, have not materialized. They were also regularly buying protection via put options, in anticipation of the sell-off that was expected to result from higher interest rates.

When the selloffs materialized, those investors sold their put protection for a profit, creating two ‘benefits’:

• The market makers who bought those puts were buying the market to unwind their hedge (helping to contain the selloff in equities).
• At the same time, the sales of the puts were also a sell of volatility to the market, helping to keep the VIX in a range.

Although the equity market saw a 20%+ decline, the real fireworks were in the bond market, which saw one of its worst declines on record.

This was reflected by the surge in the MOVE index. This is a measure of volatility on the yields of bonds of various maturities from 2 years out to 30 years.

• The MOVE index is generally higher than the VIX. An outright bond yield can move 25% (e.g from 4% to 3%) far more easily than the S&P500 can move 25% (e.g. from 4000 to 3000).
• As a rule of thumb, a MOVE above 100 indicates uncertainty (and above 150 indicates distress). When the MOVE index nearly touched 200 in March, it was the highest level since the Great Financial Crisis in 2008. It has recently dropped significantly from that level but remains above 100.

The divergence of the MOVE over the VIX (above) remains extreme today. Whilst the most shocking moves in the bond market (inflation shock and bank runs) should now be behind us, and this spread should compress over time, significant risks remain.

• Inflation, the policy response, and bank stresses are still in play.
• Risk events are still likely to spread from the bond world to the equity world.

The bond market remains the critical asset class and investors should include the MOVE index as one of the key variables for analyzing financial markets, as it will help ascertain the depth of risks ahead.

Overblown Narratives: The Dollar’s Demise

Social media (Twitter in particular) has recently been buzzing with claims that the US dollar is about to be knocked from its pedestal as the world’s leading currency. This is nothing new. The dollar’s demise as the world reserve currency is a recurring theme. (Note: The ‘reserve currency’ is the currency that forms the lion’s share of the reserves of the world’s central banks. Prior to the dollar, it was the British Pound).

But should we take the latest round of dollar-bashing seriously?