by Macro Man
It says everything you need to know about the nature of this market that yesterday's 11-point swoon in the SPX felt like a proper downdraft. If you've felt that this month has been unusually quiet, you're not alone- and with good reason. Macro Man ran a few numbers, and was startled to see that as of Tuesday's close (i.e., prior to yesterday's "collapse") there have been only five prior days in his lifetime where the 30 day historical volatility of the SPX has been lower.
(For those interested, the five days were January 3-6, 1994 and September 12, 1995.)
Yesterday's "crash" nudged the historical vol higher, but not by much; the current 30 day historical vol of 5.4% is the 23rd lowest of all trading days since the start of 1970. The days when "market volatility" served as the excuse du jour for Fed inaction suddenly seem like a long, long time ago.
US markets are hardly alone in experiencing a decline in volatility, of course; realized vol throughout global equity markets has tumbled this month. That being said, vol in the US is unusually low by global standards (as well as its own.) Amusingly, the other market that has experienced exceptionally low volatility recently has been the UK, another excuse du jour for standing pat. Tellingly, the current trough in SX5E vol is only a little lower than the post-Brexit peak in SPX realized vol.
In times gone by, of course, exceptionally low financial market volatility was a source of concern for policymakers. Such conditions, they knew, were unlikely to last but might encourage behaviour that could threaten financial stability when the volatility regime and market risk premia normalized.
Fast forward to today, and while there has been the occasional brief mention of the reach for yield, there's been nary a mention of the potentially pernicious problems posed by low volatility. The phenomenon is a relatively recent one, which no doubt explains much of the radio silence. Then again, global central banks' own policies and reaction functions have a more or less explicit goal of dampening market volatility. To paraphrase our old friend Holmes, we can put this down the the curious episode of market volatility. (The curious aspect being that there isn't any.)
Meanwhile, we are now treated to stories of state pensions in Hawaii and South Carolina implementing systematic put selling programs. While the VIX currently offers a tasty premium to realized vol, one need not possess a PhD in finance to understand how this can go badly awry. (Actually, given the financial history of the past couple of decades, perhaps we should say that one needs to not have a PhD to comprehend the risks of such a systematic strategy?)
And for what? Global central banks continue to chase the elusive bogey of arbitrary inflation targets while offering little empirical evidence that such targets can be met. The whole idea of the Fed's potentially raising the inflation target is frankly a farce. There is a veritable Everest of empirical evidence that the sort of impact that the Fed and others can have is woefully insufficient to meaningfully and permanently move the needle on inflation.
Quite possibly Macro Man's favourite finance-related fun fact, which he trots out every so often, is this: there have been exactly two months in this millennium when the 10y average of the core PCE deflator has been two percent or above. Those two months were January and February of 2000. The Fed has spent most of the ensuing period in ultra-easy mode; see if you can spot on the chart below where they are having an impact and where they are not.
Like Tantalus, the Fed (and BOJ, etc.) seem doomed to forever strive to reach the forbidden fruit of an arbitrary inflation target while falling just short. In the meantime, the negative externalities of these attempts via artificially compressing risk premia and volatility while influencing certain actors to engage in irrationally stupid behaviours may yet condemn many in the modern central banking community to a new level of the Inferno.
Copyright © Macro Man
