(Updates with Tuesday trading in VIX, adds quote)
By Saikat Chatterjee, Thyagaraju Adinarayan and April Joyner
LONDON/NEW YORK, March 24 (Reuters) - Stock and currency fear gauges that soared to levels of the 2008 global financial crisis have become less frantic since central banks and governments stepped up efforts to combat spreading economic damage from the coronavirus epidemic.
The Cboe Volatility Index, known as Wall Street’s fear gauge, was at 61.67 points on Tuesday, well below its March 16 record closing high of 82.69. It was the biggest drop over a six-day period in the index since November 2008.
In an unusual move, the VIX began subsiding last week even as stocks continued to fall. The VIX has nearly matched its levels during the financial crisis even though the recent sell-off is not as deep as the 2008-2009 crash, so the index was likely overvalued, said Matt Thompson, managing partner at Thompson Capital Management in Chicago.
While the decline in volatility will offer some respite to battered investors, it is too soon to declare that markets have bottomed out after a 30% plunge from record highs on the S&P 500 . During the financial crisis, the S&P 500 took months to find its bottom even after the VIX plummeted.
Indeed, the VIX ended Tuesday slightly above Monday’s close. Investors used recent drops in volatility as an opportunity to buy protective put options on the S&P 500 more cheaply, said Christopher Murphy, co-head of derivatives at Susquehanna Financial Group.
“By no means are we close to being out of the woods,” he said.
Currency volatility has also throttled back, though it remains relatively high.
A Deutsche Bank index of currency volatility in recent days jumped to its highest in its eight-year old history, pressuring hedge funds and risk parity funds to unwind leveraged positions in a sell-off characterised as a value-at-risk (VaR) shock.
The Deutsche indicator has retreated over the last two sessions but remains at 12.18%, well above its lifetime average.
Volatility in U.S. Treasuries has also subsided somewhat. The ICE Bank of America MOVE Index has eased since March 9, when it reached its highest level since mid-2009, though it is still elevated.
Prior to the coronavirus-induced reversal, bets against volatility enjoyed a long run of popularity as accommodative global monetary policy kept expectations for significant market moves in check. The VIX was trading below 13 at the start of the year, about a third below its long-term average.
Massive stimulus from central banks and governments - including Monday’s announcement by the Fed that it would buy unlimited bonds and backstop direct loans to companies - “has stabilised market volatility to some extent,” said Vasileios Gkionakis, head of FX strategy at Lombard Odier.
Traders typically set limits against potential losses in their operations by calculating VaR - a statistical measure used to quantify an expected loss over a specified horizon at a certain confidence level in normal markets.
VaR can tell a bank’s management how big the following day’s maximum loss for a trading floor might be. Based on previous market volatility and return metrics, a lower VaR reading would encourage traders to raise the size of their trading positions in a low volatility environment, and vice versa.
When volatility jumps, these investors exceed their limits, forcing them to cut positions rapidly in a falling market. JP Morgan calculated that last week’s VaR shock was the biggest since Lehman Brothers collapsed in September 2008.
Once volatility settles, pending flows into equities could total $800 billion to $900 billion, according to JP Morgan.
“Even if one-third of the above $850 billion of pending rebalancing flows is done over the next few weeks that should also help to reduce vol and to lift equity prices higher from here,” the bank said.
But a return to the VIX’s levels prior to the coronavirus outbreak could take months, as investors remain worried that lockdowns caused by the virus could trigger the deepest recession in decades.
“We are moving 4% a day and that kind of high vol is unhealthy. I think that vol needs to stabilise before the broader market can heal,” said Andrew Sheets, head of cross-asset strategy at Morgan Stanley in London.
Reporting by Saikat Chatterjee, Thyagaraju Adinarayan and Sujata Rao in London and April Joyner in New York; editing by John Stonestreet and Nick Zieminski