It was an odd day in the stock market, with the S&P 500 up, the RSP equal-weight ETF down, the VIX up, the VVIX up, one-month implied correlations up, and the S&P 500 Dispersion Index also higher. It’s a confusing mix because you don’t normally see the VIX and the S&P 500 rise on the same day, and it’s unusual to see both the Dispersion Index and the Implied Correlation Index up at the same time.
This tells us that implied volatility in the index is rising, and stock implied volatility is rising as well—but stock implied volatility is climbing faster than index-level implied volatility. This is likely because we’re heading into a Fed meeting on Wednesday, and risk is being repriced. Still, it doesn’t change the fact that we saw some major divergences today.
I’d be surprised if this pattern repeated tomorrow. If volatility rises again, stocks should fall—or vice versa.
Meanwhile, nine-day realized volatility is also quite low and is sitting in a zone where it doesn’t have much further to fall. Historically, the 4.5% to 5% range has marked the bottom, which probably means realized volatility is due to expand again sometime soon.
In the meantime, the S&P 500 has traded above its upper Bollinger Band for three consecutive days and has an RSI just under 70. That’s a fairly overbought condition.
Liquidity conditions continued tightening today with corporate tax payments and Treasury coupon settlements. Tomorrow, conditions should ease somewhat on Treasury paydowns, but this may have only been a dry run for what’s coming at quarter-end. Today, the average repo rate traded as high as 4.49%, which means SOFR is likely to rise again tomorrow.
That resulted in approximately $1.5 billion in trading in the Standing Repo Facility today. It’s not a large amount, but it’s the first time we’ve seen a flow of that size through the facility since June 30. The upward move in overnight rates and renewed SRF usage suggest the TGA refill is having an impact on liquidity. The pressure the overnight market faces around quarter-end could prove even greater than what we just witnessed.
One would think all of this would have some effect on the liquidity available for leverage, margin, and equity repo financing. In an environment where stocks are overbought and realized volatility is very low, that could be a dangerous combination.
While it’s extremely satisfying to see the moving parts of the market unfold as expected, it would be even more satisfying to see them all come together.
-Mike
Defined Terms and Jargon by ChatGPT
S&P 500: A widely followed index of 500 large U.S. companies, often used as a benchmark for overall stock market performance.
RSP Equal-Weight ETF: An exchange-traded fund tracking the S&P 500 with equal weighting for each stock, providing a different perspective than the market-cap-weighted index.
VIX: The CBOE Volatility Index, often called the “fear gauge,” which measures market expectations of future volatility based on S&P 500 options.
VVIX: The volatility of the VIX itself, reflecting how volatile the VIX is expected to be.
Implied Correlations: A measure of how much individual stock returns are expected to move together, based on options pricing.
Dispersion Index: A measure of how much individual stock volatility differs from the overall index volatility.
Implied Volatility: The market’s forecast of future volatility derived from options prices.
Realized Volatility: The actual historical volatility observed in asset prices over a given period.
Bollinger Bands: A technical analysis tool showing volatility bands around a moving average; trading above the upper band often indicates overbought conditions.
RSI (Relative Strength Index): A momentum indicator used to identify overbought or oversold conditions in a market.
Corporate Tax Payments: Periodic payments that reduce liquidity in the financial system as funds move to the U.S. Treasury.
Treasury Coupon Settlements: Payments related to Treasury securities that temporarily drain liquidity from markets.
Repo Rate: The interest rate on repurchase agreements, short-term loans where securities are exchanged for cash.
SOFR (Secured Overnight Financing Rate): A benchmark interest rate for overnight borrowing in U.S. dollars.
Standing Repo Facility (SRF): A Federal Reserve facility that provides short-term loans to eligible institutions in exchange for Treasury collateral, helping stabilize funding markets.
TGA (Treasury General Account): The U.S. Treasury’s operating account at the Federal Reserve, whose funding flows can affect overall liquidity.
Disclaimer
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