Expected volatility exploded last month, on August 24, after the Shanghai 300 Index dropped by 8.75 percent, its steepest year-to-date move. On Tuesday of this week, the change in the Shanghai Index from Monday’s close was a benign .93 percent, but news of a contraction in China’s manufacturing sector, as measured by the Caixin/Markit China General Manufacturing Purchasing Managers’ Index™ (PMI), was worrisome enough to turn around the majority of VIX indexes. (Expected volatility had appeared to be cooling prior to the announcement.) As shown in Figure 1, the most reactive VIX Index on Tuesday was VXST, which measures the expected volatility of the S&P 500 over the next week.
Volatility moderated after Federal Reserve Chair Janet Yellen indicated Thursday that a Fed rate increase is still on the table for this year. In a speech at the University of Massachusetts in Amherst, Yellen said current U.S. economic conditions are expected to warrant “an initial increase in the federal funds rate later this year, followed by a gradual pace of tightening thereafter.” Both the VIX and TYVIX Indexes upticked Thursday ahead of Yellen’s remarks, but eased back late Friday morning, with a better-than-forecast second-quarter U.S. gross domestic product report adding to a more positive view of the U.S. economy. The cash 10-year Treasury note yield edged higher.
Futures Also Pivot On China Data
The term structure of VIX futures also felt the contraction of China’s manufacturing sector earlier this week. The backwardation seen on Friday, September 18, had turned to a contango the following Monday. But by Tuesday’s close, it was back to backwardation.