Markets are once again lifelessly adrift near record highs as traders ponder the prospect of a summer spent blissfully floating from “key” data point to data point, knowing that the chances of a rogue inflation print breaking the spell are essentially zero or in any case, far too low to justify forgoing carry.
Monday’s session was predictably listless. It’s a holiday week and while data out of China and the release of the Mueller report (on Thursday) have the potential to cause a stir, markets are now back in the thralls of central bank forward guidance.
Just prior to the fleeting spike in rates vol. that followed the March Fed meeting, we detailed the extent to which cross-asset volatility had collapsed the most since Draghi’s 2012 “whatever it takes” moment.
“The pause in the Fed’s monetary policy tightening cycle has contributed to one of the strongest declines in cross-asset vol in recent years”, BofAML wrote at the time, adding that the synchronized decline in volatilities and credit spreads which unfolded in the first quarter of 2019 hasn’t been seen since 2014.
Fast forward a month and things have settled into an almost eerie calm (the late-March rates vol. hiccup notwithstanding).
“As risky assets have continued to outperform YTD, cross-asset volatilities have dropped materially and the VIX is now back to last year’s low of 12”, Goldman writes on Monday, adding that equity volatility has now converged with other assets.
Meanwhile, US HY implied vol. is sitting at historic lows. The following table gives you a sense of where things stand in relation to history (note the percentile and 3-month change columns).
The bank goes on to flag “safe asset” volatility (the orange line in Exhibit 1), noting that it’s now essentially flatlined. A quick look at 3M10Y shows rates vol. has quickly come back in after last month’s brief bout of excitement.
“Our rates strategists have argued the introduction of central bank ‘forward guidance’ has lowered uncertainty about the future path of short-term rates, and this plus lower uncertainty around inflation is helping to keep rate vol low”, Goldman goes on to write, adding that “the sensitivity of UST bonds to growth shocks has lowered recently.”
The bank also re-ups their volatility regime framework (we’ve been over it before) to determine where things stand currently in terms of regime probability. If you’re looking for something definitive, you’ll be disappointed. “Based on quintiles of more than 30 indicators we identified in our previous work, we found an equal probability of having a low or a high volatility regime”, Goldman says, on the way to noting that even so, “the main variables consistent with a higher volatility regime seem to be easing recently.”
Ultimately, Goldman strikes a cautious tone – call it the old “It’s quiet – a little too quiet” meme.
Obviously, assets of all stripes have run a long way since December 24, when Trump’s ridiculous tweet about Jerome Powell’s golf game made a bad situation worse on Christmas Eve. Given the sheer scope of the rally, Goldman is sticking with the cash exposure substitute theme. “With vol resetting lower, we think options are becoming more attractive both as a hedge or as a cash replacement strategy”, the bank concludes.
Perhaps that’s sage advice from the perspective of protecting gains/hedging, but as we’ve been over previously, playing for vol. spikes at a time when central banks are keen on suppressing them is a rather precarious exercise that requires not only patience, but an acknowledgement that lost carry and small losses incurred while waiting on something dramatic to happen add up over time – especially by comparison to benchmarks that have, in the post-crisis world, generally refused to roll over in earnest. Throw in the stigma attached to underperformance and you’ve got yourself a powerful incentive to chase.
Oh, and finally, don’t forget that volatility can never truly disappear – it has to go somewhere.
Right now, that “somewhere” is Washington DC.