As we first showed last week, while the equity market has remained completely oblivious to what the upcoming debt ceiling fight, which Morgan Stanley admitted over the weekend “worries us most” of all upcoming catalysts, the same can not be said of the T-Bill market, where 3M-6M yields have inverted the most on record on concerns about a potential selloff (or worse) in 3M bills which mature just after the time the US Tsy is expected to run out of cash, should the debt ceiling debate fail to result in a satisfactory outcome.
And while it is a gamble to suggest that stocks will ever again respond to any negative news or still have any capacity to discount any future event or outcome, Bank of America dares to go there, and advises clients that between seasonality, and the already record low VIX, the debt ceiling is a sufficiently risky event to expect that equity volatility will finally wake up, and that “seasonality + catalysts suggest record low vol likely unsustainable through the fall.” Here’s the big picture from Nitin Saksena and team:
While VIX has been making headlines for the most consecutive closes in history below 10 (now 8 days), medium-term VIX futures have quietly fallen to ~10-year lows, breaking the previous record from summer 2014. However, we think volatility is unlikely to sustain these extreme lows in the fall and like selling Oct VIX puts as (i) seasonal patterns suggest the VIX troughs in Jul and peaks in Sep/Oct, (ii) the VIX has “settled” below 12 in only two of the past 27 Octobers, and (iii) fundamentally, the threat of debt ceiling brinkmanship in Sep/Oct, which has already spooked the T-bill market, should help support equity volatility. For example, we like selling the VIX Oct 12 put vs. the 14/19 call spread for zero-cost upfront (Oct futures ref 13.35).
Taking these one at a time, first we focus on the seasonal aspect. What is most interesting here, is that not once has the VIX settled below 10.5 in either September or October.
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