Expectations for market gyrations are rising as investors face U.S. Senate runoffs in Georgia on Tuesday that will determine which party controls Congress, amid a resurgence in coronavirus cases.
The Cboe Volatility Index (.VIX), known as Wall Street's "fear gauge," on Monday notched its highest closing level since Nov. 5, at 26.97, while posting its biggest one-day gain since late October.
The VIX futures curve, which reflects longer-term expectations for market volatility, has also inverted for the first time since early November. An inversion of the curve suggests investors view the short-term outlook as more uncertain than the longer-term.
If either of the incumbents, Senators Kelly Loeffler and David Perdue, wins in Georgia, Republicans will maintain control of the Senate. But victories by challengers Raphael Warnock and Jon Ossoff would give control of the Senate - and Congress - to the Democratic party via a tiebreaker vote from Vice President-elect Kamala Harris. read more
While a "blue sweep" of Congress could usher in greater fiscal stimulus to aid the coronavirus-ravaged economy, it could also pave the way for President-elect Joe Biden to push through a more aggressive policy agenda, including greater corporate regulation and higher taxes. That prospect has troubled some investors on Wall Street.
"The 'blue sweep' does create some policy implications that need to be addressed," said Arnim Holzer, macro and correlation defense strategist at EAB Investment Group. "Those two barbells are keeping vol elevated."
Overall, implied volatility - the measure of anticipated market moves embedded in options prices - has jumped far ahead of realized volatility, or actual stock movements.
According to data from Susquehanna Financial Group, the gap between implied and realized volatility is near its highest level in two years for the SPDR S&P 500 Trust (SPY.P), which tracks the benchmark U.S. stock index.
The gap is similarly wide for several U.S. exchange-traded funds in technology and healthcare, sectors seen as prime targets for stricter regulation under a Democratic Congress.
Christopher Murphy, Susquehanna's co-head of derivatives strategy, anticipates implied volatility will decline soon after the Georgia runoffs, as it did after the presidential election.
Yet this time around, concerns about the COVID-19 resurgence may keep volatility elevated even after the runoff, said Amy Wu Silverman, equity derivatives strategist at RBC Capital Markets.
"A 'blue sweep' would certainly have implications for the market, but I don't see current volatility as specifically having to do with an administration change," she wrote in an email to Reuters.
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