{"id":197954,"date":"2023-10-20T12:15:00","date_gmt":"2023-10-20T16:15:00","guid":{"rendered":"https:\/\/ibkrcampus.com\/?p=197954"},"modified":"2023-10-20T13:07:23","modified_gmt":"2023-10-20T17:07:23","slug":"inversion-and-dis-inversion-vix-and-bonds","status":"publish","type":"post","link":"https:\/\/www.interactivebrokers.com\/campus\/traders-insight\/securities\/macro\/inversion-and-dis-inversion-vix-and-bonds\/","title":{"rendered":"Inversion and Dis-inversion, VIX and Bonds"},"content":{"rendered":"\n<p class=\"wp-block-paragraph\">After the close yesterday, <a href=\"https:\/\/www.bloomberg.com\/news\/articles\/2023-10-20\/volatility-market-flashes-stock-warning-in-fresh-vix-inversion\">I got a call from a reporter<\/a> asking if I\u2019d noticed that the VIX futures curve had closed with a minor inversion.&nbsp; She knew who to call \u2013 of course I had.&nbsp; Meanwhile, the yield curve \u2013 specifically the 2-10 portion of the curve \u2013 has gotten ever-closer to normalizing.&nbsp; Both of these are of significance to investors.&nbsp; Here\u2019s why.<\/p>\n\n\n\n<p class=\"wp-block-paragraph\">It is important to note that in normal times, the shapes of the VIX futures and US Treasury yield curves tend to resemble each other.&nbsp; They typically slope upwards from left to right.&nbsp; The bond yields typically rise with greater time to maturity.&nbsp; In the case of Treasuries, it generally stems from liquidity preference.&nbsp; Bond investors typically demand a greater yield for longer-dated bonds.&nbsp; The prices of longer-dated bonds are more sensitive to changes in interest rates, making them more volatile.&nbsp; Because bond investors (and in theory, long-term stock investors) should prefer less volatile instruments (all things being equal, which they rarely are), investors are usually willing to pay higher prices \u2013 demanding less yield \u2013 for shorter-term bonds than longer-term alternatives.<\/p>\n\n\n\n<p class=\"wp-block-paragraph\">Interest rates are a key reason why most futures curves -including VIX \u2013 have a similar shape.&nbsp; Futures tend to have advantageous margin requirements, meaning that an investor can control a certain amount of a commodity while only using a small percentage of the money required to buy it when the futures contract expires.&nbsp; The money that is not utilized can be invested in risk-free assets, such as T-bills, so that gives the futures curve an upwards slope.&nbsp; Nearer-term futures tend to have lower prices than their longer-term counterparts.&nbsp; That is called <a href=\"\/campus\/glossary-terms\/contango\/\">contango<\/a>, and the opposite situation is called <a href=\"\/campus\/glossary-terms\/backwardation\/\">backwardation<\/a>. (We explained this in greater detail <a href=\"\/campus\/traders-insight\/securities\/futures\/understanding-backwardation-and-contango-in-futures-markets\/\">in this piece from May 2021<\/a> and in this <a href=\"\/campus\/trading-lessons\/futures-prices-contango-backwardation\/\">Trader\u2019s Academy lesson<\/a>.)<\/p>\n\n\n\n<p class=\"wp-block-paragraph\">When a commodity that is typically in contango slips into backwardation, it means that there is an imbalance of demand that outstrips the near-term supply of that commodity.&nbsp; In the case of VIX (Cboe Volatility Index), the commodity in question is volatility protection.&nbsp; Those who wanted volatility for the past year, have found it in plentiful supply.&nbsp; This was the case even during March\u2019s banking crisis and as the conflict in the Middle East took root.&nbsp; But as of this week, the demand for volatility protection finally outstripped the currently available supply.&nbsp; In the graph below, note not only how VIX has risen sharply over the past month, but also how the shape of the futures term structure has flipped:<\/p>\n\n\n\n<h3 class=\"wp-block-heading\" id=\"h-vix-futures-term-structure-today-yellow-top-last-week-red-top-last-month-magenta-top-with-1-week-red-bottom-and-1-month-changes-magenta-bottom\"><strong><em>VIX Futures Term Structure, Today (yellow, top), Last Week (red, top), Last Month (magenta, top), with 1-Week (red, bottom) and 1-Month Changes (magenta, bottom)<\/em><\/strong><\/h3>\n\n\n\n<figure class=\"wp-block-image size-large\"><img decoding=\"async\" width=\"1100\" height=\"667\" data-src=\"\/campus\/wp-content\/uploads\/sites\/2\/2023\/10\/Picture3-6-1100x667.png\" alt=\"VIX Futures Term Structure, Today (yellow, top), Last Week (red, top), Last Month (magenta, top), with 1-Week (red, bottom) and 1-Month Changes (magenta, bottom)\" class=\"wp-image-197958 lazyload\" data-srcset=\"https:\/\/ibkrcampus.com\/campus\/wp-content\/uploads\/sites\/2\/2023\/10\/Picture3-6-1100x667.png 1100w, https:\/\/ibkrcampus.com\/campus\/wp-content\/uploads\/sites\/2\/2023\/10\/Picture3-6-700x425.png 700w, https:\/\/ibkrcampus.com\/campus\/wp-content\/uploads\/sites\/2\/2023\/10\/Picture3-6-300x182.png 300w, https:\/\/ibkrcampus.com\/campus\/wp-content\/uploads\/sites\/2\/2023\/10\/Picture3-6-768x466.png 768w, https:\/\/ibkrcampus.com\/campus\/wp-content\/uploads\/sites\/2\/2023\/10\/Picture3-6-1536x932.png 1536w, https:\/\/ibkrcampus.com\/campus\/wp-content\/uploads\/sites\/2\/2023\/10\/Picture3-6-2048x1242.png 2048w\" data-sizes=\"(max-width: 1100px) 100vw, 1100px\" src=\"data:image\/svg+xml;base64,PHN2ZyB3aWR0aD0iMSIgaGVpZ2h0PSIxIiB4bWxucz0iaHR0cDovL3d3dy53My5vcmcvMjAwMC9zdmciPjwvc3ZnPg==\" style=\"--smush-placeholder-width: 1100px; aspect-ratio: 1100\/667;\" \/><\/figure>\n\n\n\n<p class=\"wp-block-paragraph\">Source: Interactive Brokers<\/p>\n\n\n\n<p class=\"wp-block-paragraph\">While the minor backwardation at the front end of the current curve is unusual, making it notable, it is hardly at the sort of levels that indicate panic.&nbsp;<\/p>\n\n\n\n<p class=\"wp-block-paragraph\">We\u2019re far from that, at least so far.&nbsp; While some traders view an inverted VIX curve as a contrarian indicator, I believe that is incomplete.&nbsp; Major selloffs do often end while the VIX curve is in steep backwardation, but I believe that to be a necessary, but hardly sufficient requirement for a bounce.&nbsp; The curve can stay in backwardation for some time, and the sell offs end when the demand for protection becomes so extreme (very steep backwardation) that it reveals a highly oversold condition.&nbsp;<\/p>\n\n\n\n<p class=\"wp-block-paragraph\">As for the yield curve, we see a very similar pattern.&nbsp; The chart below compares the current yield curve with those from last month and two years ago.&nbsp; Of course, the overall level of rates was much lower two years ago, but the shape of the curve was relatively normal. Compared to last month, we can see how the long end of the curve has risen while the short end remains relatively stable.&nbsp; That means that the inversion has eased considerably:<\/p>\n\n\n\n<h3 class=\"wp-block-heading\" id=\"h-us-treasuries-active-yield-curve-today-green-line-last-month-yellow-2-years-ago-green-dashes\"><strong><em>US Treasuries Active Yield Curve, Today (green line), Last Month (yellow), 2 Years Ago (green dashes)<\/em><\/strong><\/h3>\n\n\n\n<figure class=\"wp-block-image size-large\"><img decoding=\"async\" width=\"1100\" height=\"611\" data-src=\"\/campus\/wp-content\/uploads\/sites\/2\/2023\/10\/Picture2-9-1100x611.png\" alt=\"US Treasuries Active Yield Curve, Today (green line), Last Month (yellow), 2 Years Ago (green dashes)\" class=\"wp-image-197957 lazyload\" data-srcset=\"https:\/\/ibkrcampus.com\/campus\/wp-content\/uploads\/sites\/2\/2023\/10\/Picture2-9-1100x611.png 1100w, https:\/\/ibkrcampus.com\/campus\/wp-content\/uploads\/sites\/2\/2023\/10\/Picture2-9-700x389.png 700w, https:\/\/ibkrcampus.com\/campus\/wp-content\/uploads\/sites\/2\/2023\/10\/Picture2-9-300x167.png 300w, https:\/\/ibkrcampus.com\/campus\/wp-content\/uploads\/sites\/2\/2023\/10\/Picture2-9-768x427.png 768w, https:\/\/ibkrcampus.com\/campus\/wp-content\/uploads\/sites\/2\/2023\/10\/Picture2-9.png 1492w\" data-sizes=\"(max-width: 1100px) 100vw, 1100px\" src=\"data:image\/svg+xml;base64,PHN2ZyB3aWR0aD0iMSIgaGVpZ2h0PSIxIiB4bWxucz0iaHR0cDovL3d3dy53My5vcmcvMjAwMC9zdmciPjwvc3ZnPg==\" style=\"--smush-placeholder-width: 1100px; aspect-ratio: 1100\/611;\" \/><\/figure>\n\n\n\n<p class=\"wp-block-paragraph\">Source: Bloomberg<\/p>\n\n\n\n<p class=\"wp-block-paragraph\">The significance here is one we have pointed out before.&nbsp; While inverted yield curves are almost perfect harbingers of impending recessions, the recessions only begin after the inversion is over.&nbsp; This is evident in the chart below:<\/p>\n\n\n\n<h3 class=\"wp-block-heading\" id=\"h-30-years-2-10-treasury-yield-spread-blue-white-bars-vs-nber-defined-start-red-and-end-green-of-us-recessions\"><strong><em>30 Years, 2-10 Treasury Yield Spread (blue\/white bars) vs. NBER-defined Start (red) and End (green) of US Recessions<\/em><\/strong><\/h3>\n\n\n\n<figure class=\"wp-block-image size-large\"><img decoding=\"async\" width=\"1100\" height=\"606\" data-src=\"\/campus\/wp-content\/uploads\/sites\/2\/2023\/10\/Picture1-22-1100x606.png\" alt=\"30 Years, 2-10 Treasury Yield Spread (blue\/white bars) vs. NBER-defined Start (red) and End (green) of US Recessions\" class=\"wp-image-197956 lazyload\" data-srcset=\"https:\/\/ibkrcampus.com\/campus\/wp-content\/uploads\/sites\/2\/2023\/10\/Picture1-22-1100x606.png 1100w, https:\/\/ibkrcampus.com\/campus\/wp-content\/uploads\/sites\/2\/2023\/10\/Picture1-22-700x385.png 700w, https:\/\/ibkrcampus.com\/campus\/wp-content\/uploads\/sites\/2\/2023\/10\/Picture1-22-300x165.png 300w, https:\/\/ibkrcampus.com\/campus\/wp-content\/uploads\/sites\/2\/2023\/10\/Picture1-22-768x423.png 768w, https:\/\/ibkrcampus.com\/campus\/wp-content\/uploads\/sites\/2\/2023\/10\/Picture1-22.png 1426w\" data-sizes=\"(max-width: 1100px) 100vw, 1100px\" src=\"data:image\/svg+xml;base64,PHN2ZyB3aWR0aD0iMSIgaGVpZ2h0PSIxIiB4bWxucz0iaHR0cDovL3d3dy53My5vcmcvMjAwMC9zdmciPjwvc3ZnPg==\" style=\"--smush-placeholder-width: 1100px; aspect-ratio: 1100\/606;\" \/><\/figure>\n\n\n\n<p class=\"wp-block-paragraph\">Source: Bloomberg<\/p>\n\n\n\n<p class=\"wp-block-paragraph\">Neither of these findings should have an immediate influence on markets.&nbsp; But they sure as heck can and should have an influence on the paths of stocks, bonds, and the economy over the coming days and weeks.&nbsp; Stay tuned!<\/p>\n","protected":false},"excerpt":{"rendered":"<p>The yield-curve &#8211; specifically the 2-10 portion of the curve &#8211; has gotten ever closer to normalizing.  Yet VIX futures slipped into backwardation yesterday.  Both of these are of significance to investors.  Here&#8217;s why.<\/p>\n","protected":false},"author":4,"featured_media":195959,"comment_status":"open","ping_status":"closed","sticky":true,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":"","jetpack_post_was_ever_published":false},"categories":[14700,18,6,8,9,26,3],"tags":[45,2961,317],"contributors-categories":[13576],"class_list":["post-197954","post","type-post","status-publish","format-standard","has-post-thumbnail","category-ibkr-market-insights","category-macro","category-north-america","category-region","category-securities","category-text-articles","category-traders-insight","tag-bonds","tag-inversion","tag-vix","contributors-categories-interactive-brokers"],"pp_statuses_selecting_workflow":false,"pp_workflow_action":"current","pp_status_selection":"publish","acf":[],"yoast_head":"<!-- This site is optimized with the Yoast SEO Premium plugin v26.9 (Yoast SEO v28.4) - https:\/\/yoast.com\/product\/yoast-seo-premium-wordpress\/ -->\n<title>Inversion and Dis-inversion, VIX and Bonds<\/title>\n<meta name=\"description\" content=\"The yield-curve - specifically the 2-10 portion of the curve - has gotten ever closer to normalizing. 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Yet VIX futures slipped into backwardation yesterday.\" \/>\n<meta property=\"og:url\" content=\"https:\/\/www.interactivebrokers.com\/campus\/traders-insight\/inversion-and-dis-inversion-vix-and-bonds\/\" \/>\n<meta property=\"og:site_name\" content=\"IBKR Campus US\" \/>\n<meta property=\"article:published_time\" content=\"2023-10-20T16:15:00+00:00\" \/>\n<meta property=\"article:modified_time\" content=\"2023-10-20T17:07:23+00:00\" \/>\n<meta property=\"og:image\" content=\"https:\/\/www.interactivebrokers.com\/campus\/wp-content\/uploads\/sites\/2\/2023\/09\/vix-volatility-featured-img.jpg\" \/>\n\t<meta property=\"og:image:width\" content=\"1000\" \/>\n\t<meta property=\"og:image:height\" content=\"563\" \/>\n\t<meta property=\"og:image:type\" content=\"image\/jpeg\" \/>\n<meta name=\"author\" content=\"Steve Sosnick\" \/>\n<meta name=\"twitter:card\" content=\"summary_large_image\" \/>\n<meta name=\"twitter:label1\" content=\"Written by\" \/>\n\t<meta name=\"twitter:data1\" 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