We noted the VIX divergence (and most importantly the 14-month flatness of the term-structure - which is following the 'debt ceiling' path perfectly!) [3] yesterday and pointed out how illiquid markets were. Critically, those that could were selling into strength and those that couldn't (due to size and illiquidity) bought protection. Overnight the flash crash recoupled S&P to VIX but this morning has seen more protecction buyers step in, driving VIX towards 20% (5 month highs). Given the recent correlations (and managers knowing full well they can't unwind their exposure into the cash market as the avalanche will be too large), VIX implies the S&P at around 1370. Interestingly, this level of S&P is also approximately what a 2% rally in the USD would imply (the FX implication we suggested yesterday [4] of a failed cliff resolution in the short-term).
VIX is implying 1370 for the S&P
[5]
A 2% rise in USD implies around 1370 for the S&P
[6]
Meanwhile, the VIX term structure is behaving EXACTLY as it did last year during the debt ceiling debate!!! The higher the chart, the higher short-term protection is priced relative to medium-term (and if greater than 1, implies short-term VIX is above longer-term VIX - which we just broke today)...
[7]
Short-term protection costs are set to soar if we follow last year's path... aren't these analogs just becoming crazy? The S&P 500 lines up far too well...
[8]
Charts: Bloomberg