Investors should be growing increasingly cautious amid expectations for tighter U.S. monetary policy, according to a new market risk indicator unveiled Thursday by the Institute of International Finance (IIF).
The IIF, which is the global lobby group for banks, says its new index is flashing a signal for caution as U.S. interest rate hikes get closer. “In light of the pending Fed exit from quantitative easing and the associated potential market risks we are offering a simple, intuitive gauge that we think is a helpful alternative to the VIX,” said Hung Tran, executive managing director at the IIF.
“Currently, the IIF U.S. Market Risk Index reflects a degree of stress building up: equities continue to gain over bonds, while the dollar index has had a decisive move higher since early July. Hence while volatility-based risk measures still show a green light, our new index suggests more caution may be warranted,” Tran said.
The IIF says that there are inherent shortcomings in using volatility as a proxy for risk tolerance/aversion; yet, the VIX, which is based on the implied volatility of S&P 500 options, is often used as an indicator of equity market risk. Its new index uses underlying asset price movements to gauge investor sentiment, by factoring in the degree of outperformance of equities over bond, the credit spread of BBB bonds over Treasuries, and the U.S. dollar index.
“The U.S. MRI effectively images different market sectors, creating a more holistic view — in this case of investor sentiment and behavior,” the IIF said.
The new index will be updated on a daily basis and, after an initial comment period, it will be made available on the IIF website and on Bloomberg terminals.