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Rising rates, big losses but so far little sign of panic in the markets


At the opening bell on Thursday, an unusually large wave of selling hit the New York Stock Exchange, with thousands of stocks sliding in tandem. The market was already nursing trillions of dollars in losses and yet few on Wall Street panicked.

“Despite some of the volatility and the moves it is actually very calm,” said Todd Sandoz, the co-head of Barclays’ equities sales and trading business. “You can feel it walking across the trading floor. It’s quiet.”

Even as the S&P 500 entered bear market territory and more than 3,500 US stocks fell to new 52-week lows this past week, gauges of volatility have not signalled the kinds of market distress registered during violent past episodes such as the start of the coronavirus pandemic in March 2020, the Chinese economic slowdown in 2015 or the US debt downgrade in 2011.

Line chart of Cboe's Vix volatility index showing Volatility shocks over the past two decades

Instead, investors seem to be adjusting quite calmly to a new world order in which central banks act aggressively to tame high inflation rates, with an uncertain impact on economic growth.

The Federal Reserve, Swiss National Bank and Bank of England all raised interest rates this past week, with the Fed announcing its biggest hike in almost 30 years. Higher rates reduce the relative value of stocks that promise profits further into the future, encouraging a sell-off that many investors and traders expect to continue.

The S&P 500 has fallen 23 per cent so far this year while the Nasdaq Composite — which is dominated by fast-growing technology companies that are particularly exposed to higher interest rates — is down more than 30 per cent.

Still, Jurrien Timmer, head of global macro strategy at Fidelity, said: “We’re still not at a point where the market could be considered cheap.”

“Any kind of recovery this year is a little bit of a hard sell,” added Peter Giacchi, who runs Citadel Securities’ floor trading team at the New York Stock Exchange. “It doesn’t mean that if the Fed . . . gets inflation under control that the market doesn’t stabilise, but to predict a sharp rally by the end of the year you’ve got to really be a bull.”

Despite the punishing declines, the sell-off has not prompted the types of forced liquidations and margin calls that can feed on themselves and cause broader market turmoil.

The relatively subdued readings in the Cboe’s Volatility Index, known as the Vix, have been catching the attention of traders all month. On Friday when the S&P 500 hit its lowest level since December 2020, the Vix climbed to 33.3. While above its long-term average of 20, it fell short of levels hit every other month this year.

Line chart of Number of stocks trading on US exchanges that have hit a new 52-week low each day showing Shares of thousands of companies in the US have slumped to new lows

“The Vix has bothered me for a while,” said George Catrambone, the head of trading in the Americas at DWS. “Investors would feel better if you had that Vix of 40, 45, 50 moment, where we know sellers become exhausted but it’s hard to have that moment until we know if inflation has peaked or not.”

Investors have pointed to the fact that hedge funds have been cutting their exposure to the markets for the somewhat muted volatility. Goldman Sachs said this week that its hedge fund clients had reduced so-called gross leverage, which tallies up their bets on stocks gaining and declining, to near five-year lows.

Traders say that has meant many funds have not been forced to beat a quick retreat when the stock market has lurched lower, dampening the selling that would otherwise be expected at any one time.

Others have noted that many funds, including big asset managers, had taken out insurance against market declines. That insurance, in the form of put options on the S&P 500 index and exchange traded funds such as State Street’s $334bn SPY and Invesco’s $148bn QQQ funds has helped soften the blow of the market’s slide for money managers.

Line chart of Number of put options outstanding on the S&P 500 index (mn) showing Investors had bought up insurance against a stock market slide

Phil Camporeale, a portfolio manager at JPMorgan Asset Management, said the multi-asset fund he helps to run had bought S&P 500 put options for just the second time in the past decade to provide protection as stock markets sank.

“It is a departure from previous times of stress where we relied on fixed- income markets to provide a balance,” he said. Traditionally bond prices tend to rise when stocks fall, but this year has seen a simultaneous sell-off across equity and fixed income.

Many investors have used the recent declines to close those equity put contracts, profiting on the market’s slide. That too has provided US stocks with some support as options dealers on Wall Street unwind their own trading books.

Dealers who sold those puts generally hedge themselves by shorting shares when the contract is first struck — in a move to avoid their own potential losses on a trade. When the put is eventually closed, the dealer will buy back the shares they had bet against. It is why on Friday, a day when more than $3tn of options expired, huge volumes in equity markets struggled to push the market decisively in one direction and volatility levels were little moved.

Traders will be watching volume and open interest gauges — which measure the number of open contracts held — on Friday and Monday to see how funds are repositioned after the mammoth equity option expiry. So far they say money managers have not been racing to buy new put contracts to hedge themselves from another drop in the stock market, even as few traders say they have much conviction in the market’s direction from here.

“It seems the sense of urgency from clients [to hedge] has been pretty light,” Barclays’ Sandoz added.

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