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The VIX Is Likely To Rise Now That The Fed Has August Jobs Data

Includes: DIA, QQQ, SPY
by: The VIX Channel

A federal funds rate hike is more likely as August payroll numbers reinforce a growing economy.

Fed officials have been making a case for a September hike over the past few weeks and through today.

A long VIX based strategy should do well given that the market is not pricing in a September rate increase.

The moment everyone has been waiting for since Yellen spoke at Jackson Hole has come, and, while I understand that I may be in the minority with this opinion, I believe the August non-farm payroll numbers have effectively given the Fed the green light to raise rates at the FOMC's September meeting. The jobs number increased by 151,000 in August, below market forecasts by around 29,000. However, the August number has been below estimates over the last several years, only to be upwardly revised afterward. The initial market reaction to the August jobs number has been positive, leading to increases in the major indices and a decline in the CBOE VIX Volatility Index. Almost immediately after the number was released, cash VIX dropped by a point while front month VIX futures dropped by 2-3 percent.

While the initial reaction to the number would indicate that the market thinks the small miss will restrain the Fed from moving rates, I believe that what we are seeing is a short term overreaction as the jobs number was still good enough for the Fed to act at their September meeting. Chairwoman Yellen has specifically commented that a number north of 100,000 would be enough to compensate for growth in the work age population. So an increase of 151,000, while below estimates, should be enough for the Fed to implement a 25 basis point increase. If they decided not to raise, Fed officials would be contradicting their own statements over the past couple of months leading to a further deterioration in their credibility.

Of course, the financial media and their guests say that because the jobs number was below economists expectations, the Fed will now hold back. This is their usual wishful thinking that subdued rates will continue to fuel increases in the already valuation stretched market indices. It seems that no matter what Fed officials say in public, the pundits do not want to believe that they will have the punch bowl pulled away. They are very happy to maintain their client base through the Fed's easy money policies no matter what the cost to the economy. And now that many analysts believe that a September rate hike is less likely, the market is pricing in a low probability of an increase through higher equity prices.

However, over the very near term, I believe we will see a decline in the market as the Fed makes its intentions even more clear that it believes conditions are close enough to their targets to move rates. This afternoon, Richmond Federal Reserve President Jeffrey Lacker spoke before the Virginia Association of Economists. In his speech, Mr. Lacker said that rates should be significantly higher than they are now. This is the first statement from a Fed official since the employment number was reported. While not a voting member on the Federal Open Market Committee, Mr Lacker made clear that he is concerned that the federal funds rate is too low.

So, I believe now is the time to implement a long VIX strategy, either as a portfolio hedge or as a speculative position. Readers of my previous articles know that my preferred method for VIX exposure is through ETNs (VXX, UVXY, TVIX, etc.) and options. VIX futures would also be an alternative. The VIX Index and VIX futures are lower than I believed they would go, given recent Fed comments, but it is better to be a bit early rather than to miss an opportunity. I want to be clear that this is a risky strategy and only for experienced investors who understand the risks and are prepared to cover themselves with somewhat tight stops. But, as a speculative position, current VIX levels are low enough to provide a good risk to return opportunity. Few believe that current low VIX levels can be sustained for much longer, and September has historically been the worst month for equity markets. With the rhetoric coming from Fed officials over the past several weeks, the most likely outcome would seem to be a September federal funds rate hike.

Disclosure: I am/we are long VIX ETNS. 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.