Bloomberg’s historical data compilation shows the near 33% decline in VIX futures over the past 2 days to be the sharpest on record, defying pundit wisdom that a cliff resolution was ‘baked in’ to the market.
Since 2004 the January 24, 2007 VIX close of 9.89 is the lowest on record – and was preceded by 4 months of trading in a 2-point range between 12 and 14; the same period in 2012 shows a nearly a 9-point range.
While the market’s response was clearly favorable to the House’s 11th hour passage of a bill staving off widespread tax increases – predicted by many economists to throw the US back into a recession – the legislation does nothing to mitigate a much greater threat posed by the pending debt ceiling. The Treasury has taken self-proclaimed ‘extraordinary measures’ to create $200B in headroom giving Congress a late February/early March deadline to strike a deal. A protracted negotiation or absence of a deal threatens the nations AA+ rating and would engulf the markets in further turmoil.
The next deadline is that of the ‘sequester,’ a series of automatic federal spending cuts ranging 8%-10% born out of the 2011 debt ceiling deal and designed as an incentive to force legislators to be effective in reducing deficits. While defense is widely projected be the hardest hit in the absence of a deal, programs across the board would suffer.
The third issue facing lawmakers is that of the ‘Continuing Budget Resolution’ and its March 27 deadline. Since Congress has been unable to agree on a real budget for years, they have instead become reliant on short-term resolutions that essentially amount to a ‘band aid’ approach. Without an agreement, expect to see a shutdown of government functions and programs.
Unless we are witness to a dramatic departure from the dysfunction of the 112th Congress – the most unproductive session in 70 years – with the swearing in of the 113th, I wouldn’t bet on VIX futures going south of 13 in Q1 ’13. Certainly not below 12, not with 3 pending ‘cliffs’ that will undoubtedly be accompanied by countdown clocks on the sidebars of various broadcast media outlets.
Further down the road in 2013, the only circumstance where I can envision a further decline in VIX levels would be if we were to see a favorable resolution to the European situation. Angela Merkel gave ominous closure to 2012, saying:
“I know that many are also heading into the New Year with trepidation. And indeed, the economic environment next year will not be easier, but more difficult. That should not discourage us, but – on the contrary – serve as an incentive.”
Based on the information outlined here, I believe we may have come very close to seeing the low VIX level for the year in 2013’s first day of trading.
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John Voorheis
KOTM Contributor
john@keeneonthemarket.com
UNC-Chapel Hill, Class of 2008
BA Economics; Political Science