Federal Reserve interest rate changes could incite greater swings in stocks and goad the CBOE Volatility Index, along with related exchange traded funds.
Jim Strugger of MKM Partners LLC argues that while the Fed rate hikes have not fueled volatility over the past two decades, the central bank’s decision this time around could be different, reports Michelle Davis for Bloomberg.
The short-term uncertainty is already have an effect on the market, with the VIX rising Wednesday. The iPath S&P 500 VIX Short Term Futures ETN (NYSEArca: VXX) and the ProShares VIX Short-Term Futures ETF (NYSEArca: VIXY) rose a little over 1% Wednesday ahead of the Federal Open Meeting Committee’s announcement. [VIX ETP Traders Anticipate More Volatility Ahead]
The VIX, which measures the implied volatility on a range of options tied to the S&P 500 index, rose an average 24% in the following days in response to previous rate spikes. Strugger, though, pointed out that the swings were short lived during low-volatility periods for U.S. equities, except for one time.
“All else equal, transitioning monetary policy has not been inherently destabilizing for U.S. equities,” Strugger said. “But this has not been a typical economic expansion.”
Strugger believes the current six-year bull cycle most closely resembles the late-expansion rate increases that started in June 1999. After rates were increased in June 1999, the VIX surged as much as 35% to a 28.5 level in the following month-and-a-half period.
Since the December 2014 low, the VIX has jumped 32% and is 7.3% above its 12-month average, which suggests that equities are in for a period of greater volatility ahead.
“If what we’re looking at here is more akin to a late cycle period of rate hikes, as was the case in 1999,” then the market may be in for heightened volatility amid a series of rate hikes, Strugger added.
While equity investors can hedge volatility with a VIX option, there are a number of ETF that specifically target the least volatile areas of the market. For instance, the PowerShares S&P 500 Low Volatility Portfolio (NYSEArca: SPLV) and the iShares MSCI USA Minimum Volatility ETF (NYSEArca: USMV) lean toward more conservative stocks. [Chilling Out With Low Volatility ETFs]
SPLV takes 100 stocks from the S&P 500 that have exhibited the lowest volatility over the past year and weights holdings by the inverse of their volatility, so the largest components show the least amount of volatility. USMV also tracks low volatility stocks, but the ETF targets variances and correlations for all stocks, along with other risk factors.
iPath S&P 500 VIX Short Term Futures ETN
For more information on market volatility, visit our volatility category.
Max Chen contributed to this article.