Andy Mukherjee is a Bloomberg Gadfly columnist covering industrial companies and financial services. He previously was a columnist for Reuters Breakingviews. He has also worked for the Straits Times, ET NOW and Bloomberg News.

Rest in peace, VIX. You're no longer the fear gauge for global markets.

Nothing to See Here
The VIX is losing relevance as a fear gauge for global markets; clues to financial tightness lie elsewhere
Source: Bloomberg

The Bank for International Settlements has found a better barometer to capture the nervousness that starts as a slight reduction in global banks' leverage, is magnified by European lenders as a dollar squeeze in Asian supply chains, and reverberates around the world as a financial tightness felt by everyone.

Everyone, except the Chicago Board Options Exchange's Volatility Index.

VIX used to be a reliable measure of pain in financial markets. But that was before the unprecedented monetary easing that followed the 2008 credit crisis. Nowadays, trouble is more likely to brew as an angina at the heart of Wall Street broker-dealers than erupt as a paralyzing stroke in the price of options for S&P 500 stocks. VIX might still spike eventually. But investors wanting to rush their portfolios to the trauma center before it's too late should be watching something else entirely. 

For a crude measure of breathlessness, look no further than the broad U.S. dollar index. For a more sophisticated view, try cross-currency basis swap spreads.

Pain's New King
Cross-currency basis swap spreads may be a more reliable fear gauge than VIX; the lower the spread, the higher the chances of trouble
Source: Bloomberg
*Average of AUD, CAD, CHF, DKK, EUR, GBP, JPY, NOK, NZD, SEK against USD.

Think of these spreads as a discount for not having the U.S. currency -- and still wanting it. A negative spread on G-10 currencies means that borrowing a unit of each of them and then converting the sum into dollars costs more than it would to borrow the greenback outright.

In theory, no gap should exist. Banks look for every opportunity to profit from any difference between the dollar interest rate implied by foreign-exchange rates and the rate available in the money market. Arbitrage would crush spreads.

Sure enough, basis-swap spreads were negligible before 2008, but now have turned deeply negative. To Hyun Song Shin, the Bank for International Settlements' head of research, they've gone from being "a rather esoteric corner of the foreign-exchange market" to "a relatively clean measure of the price of balance-sheet capacity of banks." Lenders are walking away from free money because picking it up would require leverage, and that's expensive.  

If BIS researchers are right, this could explain why Asia won't get much of an export kick by allowing local currencies to weaken against a resurgent dollar. Multi-country supply chains, greased by dollar loans, will grind slower as European banks pass on their own difficulties in procuring dollars.

Since early 2014, the basis swap has moved in perfect lockstep with the broad dollar: The higher the U.S. currency, the lower the spread. This gives rise to a disturbing scenario. If the 3.7 percent rise in the trade-weighted dollar index since Donald Trump's election victory extends into 2017, the greenback shortage in the global banking system could start causing serious earnings misses, especially in Asia.

Unless watered down or delayed, harsh Basel IV rules, expected to be announced by early 2017, might lead to European lenders scrambling for a further 900 billion euro ($949 billion) in capital. That, too, could see them tone down corporate credit to Asia, where they're a bigger supplier of dollars than more comfortably capitalized U.S. banks.

Odds are that the VIX will remain a puppet on central banks' strings, and fail to give any advance warning. For investors, it might be the time to bow to the new king of pain.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

  1. If regulation was causing the basis swap, the spread wouldn't be so volatile on a daily basis. Maybe banks outside the U.S., and especially in Europe, are still too weak. As the Bank for International Settlements' General Manager Jaime Caruana noted recently, "market pressures -- not just regulations -- have prompted banks to be more conservative with their balance sheets."

To contact the author of this story:
Andy Mukherjee in Singapore at

To contact the editor responsible for this story:
Katrina Nicholas at