After a rather calm May, volatility is back in full force in the month of June. This was anticipated. The month of June sees the Federal Reserve's FOMC and a referendum in the UK on whether to stay or leave the European Union (NYSEARCA:EU). The BREXIT issue, as Britain's potential exit from the EU is called, could in particular lead to further volatility. The ProShares Trust Ultra VIX Short Term Futures (ETF) (NYSEARCA:UVXY) and iPath S&P 500 VIX Short Term Futures TM ETN (NYSEARCA:VXX) have seen strong gains lately and I believe we are set for further upside this month.
BREXIT Creates Uncertainty
On June 23rd, the UK will hold a vote on whether to stay in the or leave it. The Remain campaign had been leading in polls over the last two months but last week five of the eight polls showed a lead for the Leave Campaign. Analysts say that if the Leave campaign wins on June 23rd, it could lead to a sharp pullback in the Pound, the British currency. The Pound itself has seen a great deal volatility as the intra-day chart, courtesy the Financial Times, shows below.
The question is what will be the cost of BREXIT. While the Leave campaign says that the cost of leaving the EU would be more than offset by the benefits such as striking bilateral trade deals, neutral analysts believe otherwise.
The EU is the biggest trading partner for Britain, accounting for half of the country's exports and imports. In a paper published last year, the Centre for Economic Performance (CEP) noted that exit would lead to lower trade between the UK and EU. Of course, the impact of this will be more painful for UK than for the EU. The paper said that in the best case scenario, BREXIT would reduce UK income by 1.1% of GDP, while in the worst case scenario UK income would fall by 3.1% of GDP. The British Chancellor, George Osborne has said that leaving the EU would cost UK households GBP 4,300 a year.
Given the gloomy assessment, it is not surprising that the prospect of Britain exiting the EU is making markets nervous. All major European indexes were lower at the time of writing this article. In the U.S., markets were down for a second consecutive day.
Apart from BREXIT, the other major event in June is the Fed meeting. The meeting kicks off this week and following the weak jobs report for the month of May, the Fed is expected to keep rates unchanged. Prior to the release of the May jobs report, the central bank had hinted at a rate hike in the summer. But the unexpectedly weak job numbers have made a summer rate hike unlikely. Still market participants are not sure about the Fed's stance. Whether the central bank sees the weak jobs report as a one-off or whether it is concerned about the state of the U.S. economy. The focus will be on the monetary policy statement, which will be released on Wednesday. Markets are expected to remain volatile ahead of the crucial statement.
The VIX Index, which measures implied volatility of the S&P 500 index options, has seen a huge spike in the last five days as the chart below shows. VIX was up more than 12% in mid-day trading on Monday.
UVXY, which seeks daily investment results that correspond to two times the daily performance of the S&P VIX Short-Term Futures, is up more than 37% in the last five days. On Monday, UVXY was up more than 14%. I expect further gains in UVXY and in VXX over the next ten days.
In terms of technicals, UVXY is about to break through its 50-day moving average. The recent gains have been accompanied by very strong volume.
As the six-month chart shows, volatility had come down significantly since February. But with the BREXIT threat becoming real, volatility has returned with a bang. Apart from the BREXIT issue and some uncertainty over Fed, market is also anxious about negative interest rates in Europe and Japan. Negative interest rates are creating distortions in the financial markets. Last week, Janus Capital's Bill Gross described negative interest rates as a "Supernova," which will explode one day.
The market had moved into a relaxed mode during the month of May but given the factors I have discussed in this article, volatility is not just back but is likely to stay. UVXY and VXX could therefore be good short-term trades.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.