Worried About Inflation?

It’s been a wild few days for stock traders.  Last Wednesday, ahead of the FOMC meeting, we warned that volatility often increased in the 3 day period after a Fed announcement. Last week proved no exception with a 1.89% fall, as evidenced below:

Three Day Chart, S&P 500 Index (SPX, white), June 16th-18th, 2021, Intraday Ticks

(Click on image to enlarge)

Three Day Chart, S&P 500 Index (SPX, white), June 16th-18th, 2021, Intraday Ticks

Source: Bloomberg

I believe that much of the move was exacerbated by Friday’s quarterly expiration of futures, index options, and stock options. Today, despite significant falls in the Asia/Pacific region overnight, stock traders are in a much more forgiving mood. Friday’s drop has been essentially erased this morning:

Four Day Chart, S&P 500 Index (SPX, white), June 16th – 21st, 2021, Intraday Ticks

(Click on image to enlarge)

Four Day Chart, S&P 500 Index (SPX, white), June 16th – 21st, 2021, Intraday Ticks

Source: Bloomberg

Many technical analysts believe that gaps need to be closed. If that is the case, consider it mission accomplished for Friday’s opening gap.

It is customary for traders to think that volatility ebbs when markets move up sharply. That is a gross misconception. Right now we are looking at 2 consecutive days with over 1% daily moves. Just because today’s move was higher does not mean that the volatility doesn’t count (my friend Steve Sears refers to days like today as “socially acceptable volatility”). Volatility measures down AND up moves, though traders are understandably less eager to hedge when stocks move higher. Indeed, we see a substantial drop in the CBOE Volatility Index (VIX), but remember that VIX attempts to measure the market’s best guess for a constant 30-day expected volatility. The current reading of 18.35 is still consistent with roughly 1% daily moves, though. [1] 

Inflation fears and potential Fed tightening are widely believed to be behind the market’s action since last Wednesday. One would think that all the talk of reflation or tapering would lead to sky-high implied volatilities in common inflation hedges. So far that is nowhere near the case. Consider the following two graphs:

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Disclosure: The analysis in this material is provided for information only and is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the ...

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