U.S. equity volatility rises as investors brace for Senate ‘blue sweep’

NEW YORK (Reuters) – Expectations for market swings are rising as investors face the second round of the U.S. Senate in Georgia on Tuesday, which will determine which party controls Congress, amid a resurgence of coronavirus cases.

The Cboe volatility index, known as Wall Street’s “fear gauge,” posted its highest closing level since November 5 at 26.97 on Monday, while posting its biggest one-day gain since the end of October.

The VIX futures curve, which reflects long-term expectations of market volatility, also reversed for the first time since early November. An inversion of the curve suggests that investors view the short-term outlook as more uncertain than the long-term.

If one of the incumbents, Senators Kelly Loeffler and David Perdue, wins in Georgia, the Republicans will retain control of the Senate. But the victories of challengers Raphael Warnock and Jon Ossoff would give control of the Senate – and Congress – to the Democratic Party via a decisive vote by Vice President-elect Kamala Harris.

While a congressional ‘blue sweep’ could pave the way for more fiscal stimulus to help the coronavirus-ravaged economy, it could also pave the way for President-elect Joe Biden to push through a more aggressive political agenda, including more business regulation and higher taxes. This prospect troubled some Wall Street investors.

“The ‘blue sweep’ creates some policy implications that need to be addressed,” said Arnim Holzer, macro and correlation defense strategist at EAB Investment Group. “These two dumbbells keep the flight high.”

Overall, implied volatility – the measure of anticipated market movements embodied in option prices – has far exceeded realized volatility or actual movements in stocks.

According to data from Susquehanna Financial Group, the spread between implied and realized volatility is near its highest level in two years for the SPDR S&P 500 Trust, which tracks the benchmark US stock index.

The gap is just as large for several U.S. exchange-traded funds in tech and healthcare, sectors seen as prime targets for tighter regulation under a Democratic Congress.

Christopher Murphy, co-director of derivatives strategy at Susquehanna, predicts that implied volatility will decline soon after the second round in Georgia, as it did after the presidential election.

Yet this time around, concerns about the resurgence of COVID-19 could keep volatility high even after the second round, said Amy Wu Silverman, equity derivatives strategist at RBC Capital Markets.

“A ‘blue sweep’ would certainly have implications for the market, but I don’t see the current volatility as being specifically linked to a change of administration,” she wrote in an email to Reuters.