(Bloomberg) -- The US stock selloff is spreading panic among volatility traders at a scale unseen since the regional bank crisis in March. In perverse Wall Street logic, that’s raising hopes that the equity rout is on its last legs.
As stock losses gathered pace Tuesday on still-surging Treasury yields, derivatives pros priced in more turbulence in the here and now than in the future.
The Cboe Volatility Index, a gauge of implied price swings in the S&P 500 known as the VIX, surged 2.2 points to 19.80, pushing the spot price above that its three-month futures for the first time since the turmoil in US lenders earlier this year.
The setup, known as inverted VIX curve, has occurred twice in the past year and both instances heralded market bottoms.
“The Treasury yield is really all that matters but a VIX term structure inverting is a sign the stress is being fully priced in,” said Chris Murphy, co-head of derivatives strategy at Susquehanna International Group. “I would want to see a VIX term inversion before I am confident this bout of selling is over.”
The S&P 500 fell more than 1% Tuesday to a four-month low as hot jobs data fueled a spike in Treasury yields amid concern that the Federal Reserve will keep interest rates higher for longer.
“Downside momentum is escalating, and technical levels are being taken out. No one knows if the higher yields are going to break something,” said Michael Purves, the founder of Tallbacken Capital Advisors. “But it feels like the chances of something breaking are only going up with this rates move.”
The VIX rose for three straight sessions, briefly topping the widely watched 20 level to close at a six-month high. The volatility gauge also climbed above its three-month futures in a departure from normal times when investors are willing to pay up for contracts further down the time horizon.
To be sure, at 0.2 point, the VIX’s premium over its futures paled in comparison to what it was during the March rout and the selloff that ended last October. The last two episodes also saw inversion lasting for days and weeks.
Still, the pattern added to a growing list of contrarian indicators that risk aversion may have reached a point that sets the stage for a market recovery. That’s what happened a year ago, when equities mounted a strong rally after everyone was positioned for a recession and then caught off caught when the economy kept chugging along.
A good example of capitulation is commodity trading advisers that surf the momentum of asset prices through long and short bets in the futures market. While mostly guided by chart signals rather than fundamental factors, the group’s exodus speaks to the worsening sentiment on equities.
Over the last five sessions, CTAs dumped more than $40 billion of shares, the most since at least 2014, data compiled by Goldman Sachs Group Inc.’s Scott Rubner shows.
“It can get worse but we’re nearing peak fear,” said Dave Lutz, head of ETFs at JonesTrading.
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