Can Volatility Go Even Higher?

06/25/2013 8:30 am EST

Focus: MARKETS

Jim Jubak

Founder and Editor, JubakPicks.com

Volatility has surged in reaction to Ben Bernanke's comments, but what is done in the week ahead will be the most important, says MoneyShow's Jim Jubak.

How high will volatility go?

A month ago, the VIX index, which measures volatility—it’s a measure of forward-looking as well as trailing volatility—was down near 12.5. People were saying, well, volatility is extraordinarily low and why and what’s going to happen and gee this is really great.

That was on, say, May 15. A month later, the index is up a whopping 53%. In fact, it was up 20% on June 20 alone.

What’s June 20? That was the day after the Fed’s strange policy statement. What you’re talking about is a move up in volatility, about 53%, from 12-something to 20-something. Now the question is, how much higher will volatility go?

Volatility is the expression of fear and uncertainty in the market. I’d argue that we’ve moved, thanks to the Fed, into a period of really pretty much fear and uncertainty.

If you take a look at what the Fed said on the 19th, which I think caused the last big surge in volatility, the Fed really didn’t give any part of the market what they wanted. Those who wanted certainty about the promise from the Fed that they weren’t going to cut back on their buying of Treasuries and mortgage-backed securities, they didn’t get what they wanted. Those in the market who wanted to hear that the Fed was going to go ahead and do it on a certain date, they didn’t get what they wanted.

Instead, what they got was a continued statement from the Fed that policy is data-driven, that the Fed will do what it’s going to do about this buying program on the schedule depending on what the data looked like.

Ben Bernanke, the Fed chairman, was very, very clear about what the schedule might look like. He said if the US economy was strong—as the Fed sort of projects—and unemployment was coming down, the Fed could consider tapering off its $85 billion in buying sometime at the end of 2013, and continue to taper off in early 2014, with the program as a whole coming to an end in 2014. Short-term interest rates would continue to stay low probably until 2015.

That’s the hypothetical schedule. What Bernanke said is that hypothetical schedule is completely dependent on the Fed getting the data it wants out of the real economy.

One of the things that struck me in the Fed statement is that it comes with a series of projections that give the views of the people on the Fed board on the economy. And they’re looking—according to these projections, according to the Fed statement—they’re looking at GDP growth of 3% to 3.5% in 2014.

Nobody that I know—well not nobody, but almost no economist outside the Fed—is looking for anything more than 2.7%. In fact, that’s where the consensus i,s according to Bloomberg. The Fed is saying yes indeed, we’ll cut back on this program if we get 3.5% growth, when no one outside the Fed is talking about 3.5% growth for 2014.

Do you see why the markets are a little uncertain? They’re basically hearing the Fed say, "We’re data-driven. This is the fantasy data that we would have to see to do this policy." But nobody really thinks it’s more than a fantasy except maybe the Fed, and does the fed really believe that? You can tie yourself in knots.

What you ought to do over the week ahead is see whether volatility starts to come down after the shock of their meeting wears off. I don’t think we’re going to see a return to that low volatility, but certainly a return to a period where we’re not seeing a surge in volatility would imply that we’re seeing a calm in the market. That’s really what we need right now to just sort of settle down and see where we are.

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