Fast reading
- The VIX Index1, widely considered a ‘fear gauge’ for US equities, spiked from 13 to 19 last week to the highest level since the Hamas attack on Gaza in October 2023.2
- US bonds were also affected. The MOVE Index3, which tracks volatility in US Treasuries, reached its highest level since January.
- Iranian oil exports hit six-year highs in Q1 of 2024, with 1.56 million barrels sold daily. Pressure to impose stricter sanctions on the country have pushed the oil price higher.
Markets retreated this week in response to escalating tensions in the Middle East. The VIX and MOVE indices both rose with a spike in demand for downside protection following Iran’s missile attack on Israel.
Adding to the risk-on mood, this week also saw a definitive end to the broader rates cut narrative that had sustained investor optimism over recent months. From initial forecasts of six Federal Reserve rate cuts in 2024, current expectations are for just two cuts this year.
In response, the blue-chip S&P500 fell 0.6% on Wednesday after investors reassessed their expectations. The yield on the 10-year US Treasury had risen to 4.6% on Thursday, while the FTSE 100 closed at 7883.4
Vincent Benguigui, Senior Portfolio Manager for Fixed Income at Federated Hermes Limited, notes the impact of this week’s events on bond markets, with yields rising sharply, and the prospect of further spikes.
“If the macroeconomic backdrop has not fundamentally changed, these moves reflect an increase in the volatility regime and a more cautious tone taken by market players,” he says. “We believe that a ‘central bank turnaround’ will remain a medium-term market driver, but we expect further market spikes in the short term due to this sudden volatility increase.”
Figure 1: Volatility persists amid global uncertanties
Under pressure
The prominence of Iran’s oil exports played a significant role in this week’s VIX spike. Here, the question of stricter sanctions on Iran created uncertainty around future oil supply and what that might mean for future inflation reads.
As oil prices continue their upward trajectory, Mo Elmi, Senior Portfolio Manager for Emerging Market Debt at Federated Hermes, points to the balance between demand and supply dynamics shaping the market.
“The recent run up in oil prices can largely be attributed to both demand and supply side factors,” he says. “The OPEC5+ production cuts instigated last year, and largely shouldered by the Saudis, seems to be paying off, while non-OPEC oil production – the main disruptor to the cartel’s dominance – is starting to plateau.”
Elmi notes how recent data paints a nuanced picture of oil production trends for key players such as Russia and the US.
“US production has flatlined at the November 2023 all-time high, while Russian upstream production has been weighed down by a lack of spare parts and logistical constraints. Although a much-welcomed relief to the oil-exporting Emerging Market countries through their external accounts, the Fed, faced with persistently strong economic data, will be keeping a close eye on energy as we enter the peak travel months of the summer,” he says.
The Fed, faced with persistently strong economic data, will be keeping a close eye on energy as we enter the peak travel months of the summer
Earnings season
Putting geopolitics to one side, Louise Dudley, Portfolio Manager for Global Equities at Federated Hermes Limited, this week considers the start of earnings season against a backdrop of persistent inflation.
“AI continues to dominate headlines as concerns over machinery orders sent chips lower, and a positive beat in chip manufacturing wasn’t able to drive the market enthusiasm we’re becoming used to around AI,” she says. “These results haven’t caused a dent in the AI thesis, but they do perhaps highlight the risk of market exhaustion with the AI theme.”
Dudley also cites strong balance sheets and sensible growth stories as important opportunities in the current inflationary environment.
“For now, it’s clear that inflation is sticky at its current bound and controlling it is now, more than ever, the job of central banks, with monetary policy, and world leaders, with foreign policy. The ability to weather an elevated rate environment and develop interesting growth opportunities could help to define the key players over the next decade.”
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1 VIX Index: This is a trademarked ticker symbol for the Chicago Board Options Exchange Market Volatility Index, a popular measure of the implied volatility of S&P 500 Index options. Often referred to as the fear index or the fear gauge, it represents one measure of the market’s expectation of stock market volatility over the next 30-day period.
2 The Financial Times, as at 18 April 2024.
3 ICE BofAML Option Volatility Estimate Index (MOVE): A yield curve-weighted index of the normalized implied volatility on one-month treasury options.
4 Bloomberg, as at 18 April 2024.
5 Organization of the Petroleum Exporting Countries (OPEC): An organisation enabling the co-operation of leading oil-producing countries in order to collectively influence the global oil market and maximise profit.
