Markets are betting on a rocky end to the debt-ceiling debate roiling Washington, but if they are wrong, investors may miss out on the gains.
(Bloomberg) — Markets are betting on a rocky end to the debt-ceiling debate roiling Washington, but if they are wrong, investors may miss out on the gains.
That’s the thinking of Amy Wu Silverman, head of derivatives strategy at RBC Capital Markets.
“The tale of optimism does not exist,” she told Bloomberg Television. “Is there a possibility of a congressional miracle? Who knows — but right now folks are pricing that this is going to be a very tumultuous debt ceiling. If it at all comes in a little bit easier than we expect, that right tail is very cheap.”
The volatility market is looking for action in stocks, and equities need to drawdown before Congress takes action, she said, adding that she expects an “eleventh hour, 2011-type” situation. Wall Street’s “fear gauge,” the Cboe Volatility Index or VIX, has been trading below 30 — a level considered a sign of heightened volatility — for most of 2023. The VIX was also tamped down in 2011 amid a similar standoff around the debt ceiling before it peaked near 50 in August and remained above 30.
“That’s what these bets in the market are saying right now,” she said. “They think we’re going to get back there.”
Lawmakers took a cautiously optimistic tone after a Tuesday meeting between President Joe Biden and House Speaker Kevin McCarthy, saying that while they remained far apart, parties were hopeful they could find some middle ground. Contracts on the S&P 500 rose in premarket trading on Wednesday morning.
Treasury Secretary Janet Yellen has warned that her department could run out of cash as soon as June 1. Rates on short-dated Treasuries expiring around that so-called X-date have soared, but analysts have pointed to a lack of reaction from equity markets, with the benchmark gauge stuck in a narrow range.
Silverman explained that the VIX is low because bullish S&P calls are cheap, and she pointed to “bearishness across the board.”
“The most underpriced reality right now is the idea that this debt ceiling situation actually gets resolved quicker and easier than we think,” she said. “Folks are very, very well prepared for a debacle. And so if we don’t get it, it would be very interesting to see all these hedges roll off.”
–With assistance from Jonathan Ferro and Tom Keene.
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