Volatility in US stocks jumps as investors prepare for a “blue sweep” in the Senate

NEW YORK (Reuters) – Market volatility expectations are mounting as investors grapple with the US Senate’s run-off in Georgia on Tuesday that will determine which party controls Congress amid the resurgence of coronavirus cases.

The Cboe Volatility Index, known as the “fear gauge” on Wall Street, on Monday hit its highest closing level since Nov. 5 at 26.97, while it posted its biggest one-day gain since late October.

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

If any of the incumbents, Senators Kelly Loeffler and David Purdue, win in Georgia, Republicans will retain control of the Senate. But the victories of contestants Raphael Warnock and John Ussof would give control of the Senate – and Congress – to the Democratic Party through the vote of Vice President-elect Kamala Harris.

While a “blue congressional sweep” could lead to greater fiscal stimulus to aid the economy ravaged by the coronavirus, it could also pave the way for President-elect Joe Biden to push through a more aggressive political agenda, including greater corporate regulation and tax increases. This prospect has alarmed some Wall Street investors.

“The blue sweep creates some policy implications that need to be addressed,” said Arnim Holzer, macro defense and liaison strategist at EAB Investment Group. “These two irons keep the volume up.”

In general, implied volatility – a measure of expected market moves included in options prices – has jumped away from realized volatility, or actual stock moves.

According to data from the Susquehanna Financial Group, the gap between implied and realized volatility is close to a two-year high for the SPDR S&P 500 Trust, which tracks the US stock index.

The gap is similarly wide for many US exchange-traded funds in technology and healthcare, and sectors seen as prime targets for stricter regulation under a Democratic Congress.

Christopher Murphy, co-chair of derivatives strategy at Susquehanna, predicts that implied volatility will decrease soon after the Georgia run-off, as it did after the presidential election.

However, this time, concerns about a resurgence of COVID-19 may keep volatility elevated even after the runoff, said Amy Wu Silverman, equity derivatives analyst at RBC Capital Markets.

“The blue sweep will definitely have implications for the market, but I don’t see that the current volatility is specifically related to a change of management,” she wrote in an email to Reuters.