A brief follow up to the $VIX discussion in this weekend’s 2020 Vision market update: US markets experienced two major volatility events with $VIX running above 40 twice during the past 4 years: 2015 and 2018. In both cases the $VIX spiked into the high 40’s. Charts suggest another volatility event of such magnitude may be coming in 2020.
Let’s walk through the evidence.
Firstly, note the obvious: Volatility events of this magnitude are rare these days. Indeed volatility is again very much contained as it always is when central banks are intervening. And ever since the Fed went from tightening to flip flopping and then outright cutting and balance sheet expansion the $VIX has been engaged in a pattern of lower highs since the December 2018 lows:
Very clean trend line. Even today it tagged the upper trend line and rejected.
Originally the same chart suggested a volatility spike to come in October, this is what I was referring to in my Real Vision interview filmed on October 9.
But frankly the Fed killed the spike. Look where and when the Fed came in with ‘not QE’:
The rest is history. The Fed added over $400B to its balance sheet and continues to this day, even today the liquidity injections via repo continue and will continue at least until the end of January, although there are doubts they can stop:
"The Fed will continue pumping tens of billions a day into the repo market through at least the end of January."
"It seems implausible to me that the Fed will be able to stop their repo operations by the end of January,” said Mark Cabana – BAML"t.co/RbSsDGCA7O
— Sven Henrich (@NorthmanTrader) January 6, 2020
But look closely at the chart. There is a lower trend line as well and despite all the liquidity injections and despite the torrent run in equities with little to no two way price discovery in December the $VIX continues to hold support, support that has held since late 2017.
So you see a compression pattern has formed. A massive one. Lower highs on the one hand and higher lows on the other hand. This pattern is coming to a conclusion sometime in the first quarter. We can’t know when, but it’s clear the pattern is running out of gas.
How meaningful is this pattern? See for yourself:
The previous mega spikes in the $VIX came following compression patterns and ironically the spikes came as the compression patterns were running out of gas, most infamously in late January 2018 going into February 2018 following another massive liquidity rally. One can’t help but compare the situation to now. In 2017/2018 the liquidity run came as a result of the US tax cuts, this liquidity run here being Fed driven.
As you can see the previous spikes produced market corrections in the 10%-15% range. We can’t know when this spike here triggers, but it could clearly occur at any time between now and early April and, if it occurs, it may run toward the 70 RSI line on the weekly $VIX chart.
During the previous events $VIX spiked into the 40’s. As $VIX appears to be very precise with its patterns one can envision a run toward the upper trend line connecting the two previous spikes to bring about a correction that could go a long way to fill many of the open market gaps also discussed this weekend.
So. Who’s ready for $VIX 46?
Note: None of this is a guarantee of course. Patterns can be invalidated and clearly the Fed keeps tight liquidity control over this market. But the Fed is supposed to end repo by the end of January and also end their balance sheet expansion by April and then markets have to contend without, ironically coinciding with the ending phase of the pattern. So should a major volatility event unfold in 2020 then don’t be surprised as this chart pattern had already suggested it being a clear and present possibility.