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What is VIX telling us ?

For beginners VIX is the Volatility index, it is the measure that has an inverse relationship with the asset price it tracks. There are various assets for which VIX is present or can be imagined. But for the sake of simplicity, we will restrict to VIX of equity assets.

From December 2021 S&P 500 (Most Tracked USA Equity Index)has gone down by 800 points falling by 17% and VIX is up by 9 points rising by 45% during the same period. But if things are looked at on a longer time scale the VIX has not played out to the level it should be, currently the highest level in 39 but historically such drops come at a level of 45 or above.

This orderly fall in equity and rise in VIX was the first goal that Federal Reserve wanted to achieve when it started to announce the reversal in policy. But as they say, it is not done till it is finished. From June, we enter the most important phase as the asset reduction program is supposed to begin accompanied by a 100 bps hike in the next two months. As per reports, the reduction will be limited to $45Bn in the first three months and then accelerate.

This is where the asset prices start to decline at a quicker pace and every asset VIX starts to rise from the base formed in the past six months. The current phase has been an eye-opener for the newbies but the next phase that might last till winter or till something breaks would be a shock and awe.

According to previous cycles, there will always be a large spike of VIX for a month or two that would result in a market breakdown and eventually lead the Federal Reserve to fold and reverse it all. Money markets have already started to price a reversal from the start of 2023 but as the path ahead is very fragile there is always a chance of sooner than later.


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