Stock market volatility has calmed this week following a significant political shift, but futures contracts indicate a potential surge in turbulence as October approaches, according to OptionMetrics.
President Joe Biden’s decision to exit the presidential race over the weekend and endorse Vice President Kamala Harris as the Democratic nominee has led to a decline in the Cboe Volatility Index (VIX). The so-called “fear gauge” of the stock market dropped nearly 10% on Monday to 14.91 and continued to dip on Tuesday, trading at 14.63—below its long-term average of 20, based on data from FactSet.
However, despite the recent calm, the VIX futures curve suggests a rocky road ahead for investors. Garrett DeSimone, head of quantitative research at OptionMetrics, points out that there’s a noticeable increase in volatility expectations moving from September to October contracts. “There’s a steep increase from the September to October contracts,” DeSimone noted. “The market is pricing in the risk of higher volatility as we approach the presidential election in November.” This trend mirrors the pattern observed during the 2020 presidential election, although overall market volatility was higher back then due to the pandemic.
Last week, the VIX surged 32.6% as anticipation built around Biden’s announcement, marking the largest weekly jump since March 2023. Despite this increase, the index fell after Biden’s decision, although the futures curve retained a steep “hump” shape indicative of expected volatility spikes.
As of Tuesday afternoon, the VIX’s September futures contract (VXU24) traded at $15.72, while the October contract (VXV24) stood at $17.75. The settlement price for the October futures contract on July 19 was approximately $18.30, compared to slightly over $16.50 for the September contract.
Beyond political factors, concerns about the Federal Reserve’s interest rate trajectory also contribute to the VIX futures curve’s shape. Investors are betting that the Fed might lower its benchmark rate as early as September, given the significant reduction in inflation from its 2022 peak. The CME FedWatch Tool indicates a 93.6% probability of a quarter percentage point cut in the Fed’s benchmark rate in September, potentially bringing it to a range of 5% to 5.25%.
This week, market participants are keenly watching upcoming economic data for further rate clues. The U.S. Bureau of Economic Analysis will release its GDP estimate for the second quarter on Thursday, followed by the personal-consumption-expenditures price index on Friday, which serves as the Fed’s preferred inflation gauge.
Despite these uncertainties, the U.S. stock market has experienced robust growth in 2024. The S&P 500 has risen 16.7% through Monday. On Tuesday afternoon, the S&P 500 (SPX), Dow Jones Industrial Average (DJIA), and Nasdaq Composite (COMP) were trading relatively flat, according to FactSet data. DeSimone highlights that, despite the macroeconomic and political uncertainties, the market continues to exhibit low volatility for now, stating, “It’s still a low vol market.”
Key Takeaways:
- Political Impact on Volatility: President Biden’s exit from the race has calmed the VIX, but futures indicate potential spikes in October as the election nears.
- Volatility Curve Insights: The VIX futures curve shows a steep increase from September to October, suggesting heightened market fears approaching the presidential election.
- Interest Rate Speculation: Traders are also wary of the Fed’s possible rate cut in September, influenced by easing inflation.
- Economic Data Monitoring: Investors await significant economic indicators this week, including GDP and inflation data, for further market direction.
- Market Performance: Despite volatility concerns, U.S. stocks have performed well in 2024, with major indices showing substantial gains.
Conclusion:
As the U.S. presidential election draws nearer, investors should prepare for potential volatility spikes in October. Political shifts and interest rate speculations are crucial factors shaping market expectations. While the stock market has demonstrated strength this year, the steep futures curve of the VIX serves as a reminder of the uncertainties ahead. Traders must stay vigilant, closely monitoring economic data and Fed decisions to navigate the anticipated market turbulence.
