The VIX remained at post-credit crunch lows during much of the spring and early summer.
But the persistence of some of the macroeconomic themes together, perhaps, with the withdrawal in June of QE by the US Fed, has recently undermined this resilience. We have seen the VIX hit 20 twice in the past four weeks in what appears to be an upward trend.
US macro risks
Key macro risks include weak labour and housing markets in the US leading to an extended soft patch for the economy. Recent weak employment data suggests that the US may be suffering from a structural, not a cyclical, unemployment problem. This bodes ill for long-term consumer demand growth in what is still the world’s largest economy.
In addition, investors sense that the eurozone and US debt problems are coming to a head and that the risk of policy uncertainty has increased.
In the eurozone, the bond markets are forcing the authorities to choose who will ultimately pay for Greek, Irish and Portuguese sovereign and bank debt. In essence, the debates are over whose tax payers will pick up the bill, those of debtor or of creditor countries. The recent hike in Italian bond yields has given the crisis a fresh urgency.
Macro drivers
Meanwhile in the US political gridlock between the two major parties has made deficit reduction intractable, as the 2 August deadline for extending the $14.3trn debt limit approaches.
But when agreement does come, what will the effect be of a mix of higher taxes and cuts in federal spending on consumer spending? And what will the effect be on yields, and on growth, if the rating agencies downgrade US Treasuries in the absence of any deficit reduction plan?
As summer turns into autumn we should have greater clarity on the extent of the US soft patch on corporate earnings, while – if the current pressure persists – the eurozone and US debt crisis may have passed through a cathartic shock. We can then reassess the outlook for risk assets.
But in the meantime expect uncertainty to persist and the VIX to remain at current levels, or higher.
