Enis’s Macro Wrap – Changing Nature of Volatility

by Enis November 29, 2012 7:54 am • Commentary

The past 4 months have been the first 4 month period since late 2006, early 2007 that the VIX has not breached the 20 level.  In the context of market history, there have been longer periods when the VIX has not breached 20 (it did not breach 20 for the whole of 2005), but the past 4 months is notable when considered in the context of global markets that face considerable economic and political shifts.

This subdued volatility has not been confined to equity markets.  FT Alphaville has a good chart this morning, courtesy of Merrill Lynch, showing the low volatility of the EURUSD currency pair:



The monthly range for the cross is at 5 year lows, and other FX pairs are showing similar calm.  What’s the Merrill Lynch analysts’ thought on the cause of this calm?  You can read the whole piece for detail, but they reach a two-pronged conclusion.  First, low interest rates globally decreases the volatility of prices, “as lower inventory costs promote the smoothing of transient shocks, and can increase price correlation if common shocks are more persistent than idiosyncratic shocks.”  Second, since common shocks (globally synchronized impacts) have more of an impact in a low interest rate environment since global policy is similar, the periods of low volatility, when interrupted, will be broken by rare periods of high, correlated volatility.

That sounds like what markets have experienced over the last 3 years.  Given that low rates are here to stay, expect more of the same in the next year.

Markets overnight:

  • Markets took the green baton from the U.S., as Asia was uniformly higher with the exception of China, which was lower again
  • Europe is up 1%, and has been green all session on little news.  SPX futures indicate a 0.5% higher open
  • The dollar and Treasury bonds are weaker, and commodities higher, reversing yesterday’s losses
  • U.S. GDP, Personal Consumption, and Initial Jobless Claims data will be released at 8:30 am EST this morning