A Liquidity Crunch & Volatility Surge Is Coming In 2022
Multiple waves of uncertainty have swept over Wall Street in the past month: concerns about rising wages and inflation, Federal Reserve turning more hawkish, and the Omicron variant becoming widespread. These increasing waves of uncertainty drive rising implied volatility (VIX). The following chart shows the 200-week moving average of VVIX (Volatility of VIX) has slowly moved upward since the March 2020 correction.
Source: Patrick Hill – 12/7/21
Note how the Bollinger Bands (pink and tan) for 2 and 3 standard deviations have dramatically expanded in the last few weeks. We expect with all the uncertainty heading into 2022 that high volatility will be the new normal for markets.
Volatility Rise Triggers Futures Liquidity Crunch
Analysts have penned many posts about how the Federal Reserve tapering of bond purchases and possible interest rate hikes in 2022 will cause a liquidity crunch for investors. Another faster-moving factor is adding to the liquidity crunch. That factor is liquidity falling in futures and derivatives markets when volatility rises. The following graph from Goldman Sachs shows how futures liquidity falls as the VIX rises.
Sources: Goldman Sachs, Bloomberg, The Daily Shot – 11/30/21
When liquidity falls, the decline in prices accelerates due to fewer buyers. Futures and options volumes are now greater than volumes in the underlying stocks. Thus, derivatives have an increasing influence on market prices and movement. Next, we look at factors driving uncertainty.
Covid Will Keep Uncertainty High
Covid virus variants seem to be popping up more, as we saw with the Thanksgiving Day report of Omicron. The reality is people are still anxious, even with vaccinations, but the rate of vaccinations has not been high enough to achieve ‘herd immunity.’ Last year, experts said that a 70% vaccination rate was necessary to achieve herd immunity. According to the Mayo Clinic vaccination tracker, the U.S. has about 60% of the adult population fully vaccinated. The country is not getting beyond the virus as people still fret about parties and family gatherings while dividing people into vaccinated and unvaccinated groups. Virus stress is impacting consumer expectations.
Consumer Spending Likely to Drop in 2022
Consumer sentiment continues to drop to decade lows as people are increasingly concerned about the virus and its impact on their income. The following chart, courtesy of Danielle DeMartino Booth shows workers’ concern about future income and buying climate expectations are falling.
Sources: The Daily Feather, Langer Research, University of Michigan – 11/18/21
The present Christmas holiday buying spree is likely due to pent-up demand. Beginning in January, consumers will have the harsh reality of rising inflation and uncertainty about future income facing them. The consumer sentiment about income contrasts with the high level of job quits and millions of job openings. It would seem that workers would be quite confident about their income prospects. But we suspect that the virus still being a factor in everyday life, and they are worried that lockdowns or job layoffs could come back. Inflation raging is another factor adding to consumer uncertainty.
Inflation Out of Control
Price increases are surging to levels not seen in a decade as the Personal Consumption Expenditure index is now at 5%. Wages seem to be driving inflation as the following graph indicates wages in pandemic-related industries are soaring above CPI.
Sources: Labor Department, The Wall Street Journal – 12/7/21
Inflation is becoming embedded in several economic sectors, including housing, warehousing, and transportation. The most recent Case – Shiller Housing price index shows existing home prices rising year over year at 20%. Warehousing vacancy rates at 3.6% are at the lowest level in twenty years. CBRE Group, a real estate firm, reports that leasing companies are now charging premium prices of 25% on average in longer-term contracts. The port of Los Angeles, while reducing the number of ships to 60 today, is awaiting offloading reports of 90 more ships coming to the port. Container shipping rates from Shanghai to Los Angeles are 121% of the rate before the pandemic, reports Xeneta, a freight cost analysis company. These price increases will trigger price markups for consumer and industrial products and related services.
A Roller Coaster Economy in 2022
Besides all the uncertainty trends we have noted above are the coming mid-term elections. Politicians will be battling on policies while not solving many problems. The division between political groups will increase and add to in place uncertain economic trends.
Wall Street has been insulated from much of the uncertainty that workers and consumers feel today by virtue of the Federal Reserve providing historic levels of liquidity. In November, Jerome Powell announced in his testimony to Congress that the term ‘transitory’ describing inflation should be retired. The days of easy money on Wall Street are ending in 2022. What is likely to be the result of this new liquidity reality? Expect the unexpected. Monitor these trends and be agile. Who would have predicted a 100-year pandemic 2020 event a year earlier? With all the changes happening in the world today, the social and government forces that provided guardrails are weakening. We could see significant dislocations and economic swings. A liquidity crunch is on the horizon. Buckle up for the roller coaster ride.
Mon, 12/13/2021 – 10:02
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