Thanks almost entirely to Donald Trump’s “greatest” tariff escalations and cringe-inducing penchant for communicating momentous policy decisions via typo-ridden tweet, last week was chock-full of headline-worthy market developments.
Not the least of those developments were the inversion of the VIX curve and, relatedly, a massive three-day move in the VVIX/VIX ratio. “VVIX and Skews at such extremes obviously iterates the outperformance of VIX versus S&P”, Nomura wrote Wednesday, in the course of documenting the action.
On Monday, as trade tensions flared anew, Goldman’s Rocky Fishman (who, you’re reminded, essentially predicted the VIX ETN extinction event while he was at Deutsche Bank), was out with a brief note on the subject. Although there’s nothing “new”, per se, in the short piece, it’s good for a few quotables.
“Term structure inverted sharply, skew spiked, and the VIX’s increase significantly exceeded what realized vol or the spot sell-off would imply”, Fishman recounts, adding that “with term structure hitting one of its most inverted moments of the last few years, markets were implicitly pricing the trade negotiations as if they were one of the most important catalysts we’ve had for years.”
(Goldman)
He goes on to pose a leading question with ominous overtones:
If the VIX rises 10 points on a 4% sell-off, what would it do on a larger downturn?
The short answer is that vol. won’t “disappoint” (scare quotes are there for a reason) in the initial stages of a hypothetical drawdown. After putting that out there, the discussion comes pretty quickly back to liquidity or, more to the point, a lack thereof.
For months, Fishman has warned that market depth has not improved as much as it “should” given declines in volatility and the concurrent rally across risk assets. He reiterates that on Monday, noting that while Goldman doesn’t see positioning in VIX markets as an issue (that’s the whole “be sure and take a nuanced approach to understanding speculative positioning” story), liquidity is a potential problem.
“As volatility subsided in April, SPX futures’ top-of-book depth did not quite get back to the level they reached in September, just before the Q4 sell-off”, Fishman writes, before delivering the following, ummmm, lukewarm take on liquidity provision during last week’s tumult:
The $10mm median top-of-book depth for SPX E-mini futures last week was a sharp drop from the previous week’s $23mm median, but a drop that is to be expected with heightened volatility. SPX E-mini futures traded $360bln/day of notional last week – a volume that would be consistent with realized vol well over 20% (though close-to-close realized vol last week was only 13%) – so in the context of strong index volumes, top-of-book depth metrics could have been stronger.
Here are updated versions of two charts from Fishman that we use fairly often to illustrate the extent to which liquidity/market depth remains severely impaired, certainly relative to most of 2016 and all of 2017 (left pane) and disappears almost entirely in a pinch (more granular, right pane).
(Goldman)
Ultimately, Fishman reiterates what he said in one of his last notes, which is that it’s still an opportune time to hedge – “especially with 6-12 month puts continuing to have lower-than-usual carry”.
