BOJ Risk Looms As Volatility Compression Sends Stocks Higher

Navigating the Market members received this update today:

Stocks finished the day higher, with the S&P 500 climbing by 55 bps. As noted yesterday, there is not much IV left to crush, and after we are scraping the bottom of the barrel. The VIX is back to 15.6, and the 1-month implied correlations are back to 8.6, so if the market is going to rise, it’s going to have to do the old-fashioned way, with genuine buyers and sellers, not just option positions unwinding and dealer hedging flows.

The last 3 months have shown pretty much what happens to the market when you suck all the liquidity out of it and suppress volatility. Nothing. We are in the same spot we were in on basically October 29.

On Friday in Japan, which will be Thursday night in New York, the BOJ is set to decide what it will do with interest rates. At this point, the BOJ is in a really awkward position. They aren’t expected to raise rates, and while they keep talking about future hikes, they are clearly taking their time, which is why USDJPY is at risk of weakening further, and bond yields could rise. I don’t know what they do or say. From what I have seen, they are expected to leave rates unchanged and up their growth projections.

A BOJ that comes across as too weak probably means the USDJPY is on its way to 162, and maybe beyond. There is very little resistance between the current spot at around 158.40 and the 162 region.

On top of that, I would think the bond market will do what the BOJ is afraid to do: push rates higher. Right now, the 10-year JGB is trading between 2% and 2.4%.

I do think the BOJ meeting results are important and could impact global markets. Again, implied volatility levels here in the US are low for both equities and bonds. Those levels did increase on Tuesday, but they came right back down over the past two days.

Maybe they try to shock the market and actually hike, I don’t know, but whatever the case may be, it will be something to watch.

-Mike

Glossary by ChatGPT

• Dealer Hedging Flows – Trading activity by option dealers adjusting hedges to manage risk from changes in underlying asset prices.

• Implied Correlations – Market-implied measures of how closely individual stocks are expected to move together, derived from option prices.

• Implied Volatility (IV) – The market’s expectation of future price fluctuations, inferred from option prices rather than historical movements.

• JGB (Japanese Government Bond) – Debt securities issued by the Japanese government, serving as a benchmark for Japan’s interest rates.

• USDJPY – The foreign exchange rate measuring the value of the U.S. dollar relative to the Japanese yen.

• VIX – The CBOE Volatility Index, often referred to as the market’s “fear gauge,” reflecting expected volatility in the S&P 500.

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