fungible thoughts

The Fed is now shrinking its balance sheet; they are no longer buying new securities as they mature. Below is a bit of analysis on if the Fed’s recent activities in shrinking its balance sheet is the cause of the recent rise in volatility.

Quick note: Data is at a weekly tenor, from Jan. 8, 2014 to April 4, 2018.

The thinner vertical line denotes when the Fed began to shrink their balance sheet last October; the thicker vertical line denotes when we had that massive vol spike in February of this year.

On the surface, the Fed’s action doesn’t appear to be the cause of all the hullabaloo, i.e. the shift from risky assets to safer assets.

If we turn to bonds, we see the following.

Rates on 10-Year Treasurys have moved higher since the Fed began shrinking it’s holdings of US Treasurys. Recall, bond prices fall as rates rise. Less buyers = lower prices = higher rates.

It appears these movements aren’t directly related to the recent rise in volatility.

However, there appears to be an inverse relationship between bond rates and the VIX Index.

A simple linear regression would see if the markets follow each other and if there was any preditcability between the markets. The equation is as follows:

Regression Summary:

We see a significant coefficient, with a value of -8.545, and an insignificant alpha. Therefore your new equations is:

If you predict a 25 bps rise in bond rates, we would expect to see a 2.3136% fall in the VIX Index, with 95% confidence:

The VIX is crazy volitile and the regression has a small R squared, so take the results with a grain of salt.

Thanks for reading,

/tommander-in-chief

Sauces:

1. http://www.statisticshowto.com/probability-and-statistics/f-statistic-value-test/
2. https://www.cnbc.com/2015/09/25/what-happened-during-the-aug-24-flash-crash.html
3. https://fred.stlouisfed.org/series/TREAST
4. Yahoo Finance
5. Bloomberg

Note: The VIX and the 10-Yr are already percentages, so they’re calculated in absolute terms.

Delta VIX = VIX Value Today – VIX Value Yesterday

Delta 10-Yr = 10-Yr Today – 10-Yr Yesterday