In the past week, since the better than expected jobs data, the VIX has risen 70%. Yesterday it closed above 20 for the first time since October 20th (when the SPX was more than 100 points lower than where it is today.) There is a growing angst amongst investors that has not exactly manifested so far in equity prices (at least here in the U.S), but is very visible in safe haven assets like U.S. Treasuries, the U.S. dollar. Conversely you see it in some increased volatility in the high yield debt markets and obviously with equity volatility products. Crude Oil is the main event and all discussions of price movements in other risk assets us start and stop with what’s happening in black gold.
It has been fascinating to track the sentiment associated with the crude decline. When crude oil went from $105 in June to $90 in September it was considered a boon for corporate profits and consumers. And then when Crude went from $90 to $70 it was widely seen as a tax break for consumers at the perfect time. But now with crude nearing a 50% decline from its June peak the tone has changed. If Crude meaningfully breaks $60 we could see an all out panic in risk assets as it becomes apparent that no one knows where the bottom is and what it the crash in prices means. The near universal declaration that lower oil will have positive affects from Wall Street to Main Street seems a bit pedestrian to me and smacks of the Bernanke Fed’s assurances that the Subprime debt situation was “contained” in 2007. As in 2007 it seems like no one really knows the extent of the counter party risk associated with a decline in an important asset class this fast.
Last night on CNBC’s Fast Money we discussed the volatility of oil prices and the impact on equity prices. It’s a pretty complicated set up with currencies, commodities, foreign equity markets and interest rates whirling around the way they been, but I have reached the conclusion that the oil price collapse may have more to do with the fact that the Federal Reserve has concluded the QE experiment, and that oil prices were a direct benefit of the Fed’s stimulus.
The weakness in oil is a reflection of weakening global growth. There has been little to cheer about in China and Japan despite active easing, in Europe where the ECB has hinted at easing, and don’t get me started about Russia and Brazil. The worry here is that the oil collapse causes all sorts of cuts in economic activity, including job cuts, with the potential of causing some sort of credit event. Oil and related companies will start slashing dividends, risk defaulting on debt followed by some bankruptcies.
What will the knock-on effect be? Will we also see sovereign debt defaults in places like Russia, Brazil and Venezuela where their economies are so tied to the demand for crude? Buckle up.