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VIX Index: US Election Uncertainty to Drive Market Volatility

VIX Index: US Election Uncertainty to Drive Market Volatility

2020-10-06 22:15:00
Rich Dvorak, Analyst
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VIX INDEX ‘FEAR-GAUGE’ TENDS TO RISE HEADING INTO US PRESIDENTIAL ELECTIONS AS EXPECTED MARKET VOLATILITY CLIMBS ALONGSIDE POLITICAL UNCERTAINTY

  • S&P 500-derived VIX Index historically advances ahead of US presidential elections
  • Expected stock market volatility likely accelerates with rising policy uncertainty
  • Donald Trump and Joe Biden are toe-to-toe in the latest November 2020 election polls

The VIX Index, often referred to as the fear-gauge by traders, reflects expectations for stock market volatility over the next 30-days. Expected market volatility is conceptually tied to the overall level of perceived uncertainty, which is typically elevated around high-potential impact event risk. One historical example of this is how the VIX Index tends to climb heading into US presidential elections.

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VIX INDEX NORMALIZED TO ELECTION DAY (CHART 1)

VIX Index Price Chart Market Volatility US Presidential Elections

On average, the VIX Index trades at a higher level on US election day when compared to readings taken in the 60-days prior to the November election date. Though this may not always be the case, and the number of historical observations are limited, the relationship may broadly be explained by investors hedging against uncertainty and downside risk that stem from potential political regime changes. Expected stock market volatility tends to start stabilizing and retracing back lower following the election, but this is less likely to occur if there is a shift in party control.

Looking at the 2008 election cycle, for example, the VIX Index nearly doubled in the two-month period leading up to the November election date. The ‘fear-gauge’ continued climbing after the 2008 election, which revealed a change in political party occupying the White House from Republican to Democrat.

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The 2000 election cycle also provides an example of the VIX Index rising in the days leading up to election day and advancing further afterward as markets digested policy changes that accompanied a change in presidential leadership from Democrat to Republican. That said, it is worth mentioning that the 2000 election and 2008 election both occurred around major financial crises.

VIX INDEX LEVEL AROUND US PRESIDENTIAL ELECTIONS (CHART 2)

VIX Index Price Chart S&P 500 Implied Volatility Around US Presidential Election Cycles

Volatility looks primed to rise over the coming days and weeks as the November 03, 2020 election day approaches. This is considering the historical behavior of the VIX Index typically observed during past election cycles, as well as the current geopolitical and economic landscape. The US economy is coming off one of the sharpest downturns in modern history in response to the coronavirus lockdown earlier this year, though recent economic data points to a robust recovery in business activity and employment.

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Further, potential for heightened volatility around the 2020 presidential election might be exacerbated by social distancing measures, which looks likely to result in a major jump in the quantity of mail-in ballots. The time-consuming process of tallying mail-in ballots could draw out the election results and bolster the sense of uncertainty which in turn further lifts the VIX Index. This is a particularly amplified scenario considering US President Donald Trump and former Vice President Joe Biden have been polling neck-and-neck in most 2020 election polls. Ultimately, this heightened uncertainty and ambiguity around the election’s actual outcome has the potential to further exacerbate stock market volatility beyond just November 3rd.

-- Written by Rich Dvorak, Analyst for DailyFX.com

Connect with @RichDvorakFX on Twitter for real-time market insight

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

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