If Federal Reserve chair Kevin Warsh wanted to put the bond market on alert, he certainly got his wish Friday: odds of an interest-rate hike by the central bank in its September meeting jumped to nearly 60 percent after Warsh’s speech in Jackson Hole, compared to just 35 percent on Thursday, according to Fed funds futures odds tracked by CME Group.
What may be a welcome surprise for the Fed: there are strong signs stock traders seem to be OK with it.
The Cboe Volatility Index (VIX), which measures the price of 30-day options on the S&P 500 Index, fell to as low as 14.1 in the aftermath of Warsh’s first delivery at the annual symposium, its lowest reading all year.
While stocks slipped midday as shares of Nvidia unwound some of its big earnings gains, the S&P was down three-tenths of a percent, about half the roughly 60 basis-point range options pricing had implied for Friday’s session. U.S. equities looked particularly strong in comparison to bitcoin and gold, which each dropped at least 2.5 percent – further evidence that investors across asset classes are preparing for higher interest-rates.
“The VIX is low because a Fed that is vigilant on inflation without having to hike aggressively is seen as positive for the economy to bring inflation down, bolstering the bull case for stocks,” Ben Emons, managing director at Highline Asset Management, said in a text.
Cboe Volatility Index, YTD
A more comprehensive look at S&P 500 volatility that includes options expiring beyond the VIX’s range suggests the impact of higher interest rates may not be seen for several months, argues Cboe’s derivatives market intelligence head Mandy Xu.
“Uncertainty around inflation/path of rates will have an impact on longer-term equity volatility, which is why the SPX term structure has steepened so much,” Xu wrote in an email.
The spread between the price of six-month options and 1-month options on the S&P 500 is currently in the 96th percentile of the past year, according to Cboe data.
Late-February VIX futures are currently priced around 21, compared to just under 16.9 for the active contract, according to ThinkOrSwim data. It’s a notably steeper curve than a month ago, when front-month contracts were near 20. Still, the entire curve has shifted lower as volatility generally subsides.
“The Fed is still technically in ease mode,” James Perry, founder and chief investment officer of Perry International Capital Partners, said in a text. “When oil goes down, inflation expectations will fall further.”
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