- As the global market dive continues, some in the market believe the rout could spread and become part of a wider drop in global asset prices.
- ING strategist Viraj Patel argues that the lack of a major reaction in the FX markets is a good omen that the current global stock rout won’t spread.
LONDON – As the global market dive continues at pace, some in the market believe the rout could spread and become part of a wider drop in global asset prices.
The Cboe’s Volatility Index, which measures investors’ expectations of future stock price fluctuations and is commonly referred to as the “fear index,” has spiked, as stocks have dropped around the world.
So far falls have broadly been contained to stocks, but that could change, with market linked products like ETFs one of the areas causing most concern.
Analysts at ING however, urged caution, pointing to a chart showing that in historical terms, “the contagion effects to other asset markets from the current stock market rout” have been “relatively muted.”
That’s particularly true when it comes to currencies, according to Forex strategist Viraj Patel.
“We note that moves in currency markets – notably USD/JPY – have not been as disorderly as had been the case in prior instances when the VIX has unexpectedly spiked; past episodes on average have seen USD/JPY move lower by around 1.2 standard deviations more than the current move (ie, USD/JPY should be trading closer to 107 based on the extent of the current VIX spike),” Patel wrote a little earlier.
As the chart shows, stocks, oil, and short term US bond yields have reacted more aggressively than historical spikes in volatility, but longer term yields, as well as forex, have underreacted. That, Patel believes, is a good sign about the overall health of the market, and suggests this is more a correction than a full scale market crash.
“Our initial takeaway from this is that the current equity market sell-off may be a result of prior over-exuberance for risky assets – which were not necessarily reflected in other asset markets,” Patel argued.
The VIX reflects expectations for volatility in the stock market. It typically rises when stocks fall, and traders anticipate big swings in prices. Until this month, the vix was skirting record lows as shares steadily climbed.
“Therefore in an environment where we continue to see a non-fundamental stock market correction, the spillover effects to other bond and currency markets may continue to be limited in size and extent.”
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