Volatility-linked investment strategies are joining the nascent sell-off in U.S. stocks and could help accelerate declines if market gyrations keep increasing.
Though the S&P 500 is still up about 5% year-to-date, further gyrations could trigger more selling from the funds: analysts at Nomura estimate the strategies could dump some $45 billion worth of stocks if the S&P 500 averages daily moves of 1% over the next two weeks. While that is small compared with the S&P 500′s $42 trillion market capitalization, the funds’ tendency to follow market momentum can sometimes exaggerate stock moves, market participants said. Other, slower moving strategies could also join in if volatility increases.
Volatility has picked up in other asset classes as well. The MOVE index, measuring expected volatility in U.S. Treasuries, stands at a three-month high following a steady rise in Treasury yields. The Deutsche Bank FX Volatility Index , a measure of currency market swings, has climbed to a near 10-week high in the face of a rally in the U.S. dollar.
However, “the funds are quite susceptible to a massive unwinding from the currently high level of equity allocation, particularly if volatility reprices higher in case inflation keeps surprising to the upside, limiting the Fed’s ability to cut rates,” according to Barclays. Nomura’s McElligott said CTAs could sell some $31 billion in equities if the S&P 500 falls another 2% to around the 4,914 level in the weeks ahead.
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