The same factors which’ve mitigated the impact of the Fed’s hiking cycle on corporates and households have likewise impaired the transmission of higher rates to volatility.

That’s according to JPMorgan’s Marko Kolanovic and Bram Kaplan, who generally expect equity volatility to be higher in 2024 than it was this year.

“Historically, we typically saw an ~18 month lag between rates and volatility levels, but lags in the transmission of monetary policy are longer this time due to high consumer cash balances, corporates and mortgages locking in low rates, pent-up demand from post-COVID reopening, fiscal expansion, cushions to the energy crisis and wealth effects from increased asset prices,” Kolanovic and Kaplan wrote.

Kolanovic has been fairly adamant that we haven’t seen the last of the fallout from the hiking cycle. He reiterated as much in the bank’s 2024 vol outlook. “Much of the impact of monetary policy is likely still to come,” he cautioned, noting that the VIX should be around 20 currently based on dozens of macro variables.

The figure on the left illustrates the 18-month lag mentioned above. The table on the right is the fair value VIX calculation.

One implication is that if fair value is 20 now, when macro conditions are favorable, it’ll be meaningfully higher in the event conditions deteriorate, and that’s to say nothing of familiar self-referential dynamics which, while highly effective at suppressing vol, are also very efficient in driving it higher in the presence of adverse developments.

“Market liquidity remains structurally weak (though improved somewhat this year), which can provide a boost to volatility levels as flows have increased market impact, particularly during selloffs that can spark negative feedback loops between volatility, liquidity and flows,” Kolanovic said.

Of course, any time you endeavor to forecast volatility, you have to take account of structural factors capable of suppressing it for long periods of time. Marko spoke of “virtuous cycles” which can lead to disconnects with rates and macro developments. He cited option-selling and dealer hedging flows, and the read-through of range compression for vol control exposure.

All of that was in play recently, as realized vol collapsed, triggering re-leveraging from the target-vol universe.

Kolanovic repeated his periodic warning that a “similar” event to February 2018’s historic “Volmageddon” episode (which, you’re reminded, played out on Jerome Powell’s very first day in the big seat) isn’t out of the question, even if the star-crossed protagonists aren’t former big box logistics managers shorting vol from home offices in the suburbs this time around.

“In case of a market shock, vol sellers could be at risk of a disorderly unwind,” Marko wrote, adding that “investors shouldn’t be lulled into thinking a vol shock can’t happen just because the VIX is low.”

As a reminder (and without wanting to create any undue angst), the appearance of calm can be a precursor to acute bouts of volatility given modern market structure. That’s a recurring theme. It’s the “avalanche waiting on a skier’s scream” setup. “Recall that one month prior to the 2018 episode, the VIX traded at all-time lows,” Kolanovic remarked, before conceding that “trying to pinpoint the timing of such a shock is difficult, and the vol suppression we saw this year is likely to persist until something breaks.”

It’s also important to recognize the vol-suppressing effect of offsetting single-stock moves. That’s been a defining feature of markets at various intervals in recent years, in part due to the tendency for mega-cap tech to diverge from other sectors. Marko cited “the plunge in stock correlation” as another driver of subdued vol.

Finally, Kolanovic and Kaplan addressed the geopolitical outlook which, as you might’ve surmised from all the missiles flying around, is fraught. “The pace of geopolitical developments hasn’t been seen since the fall of communism,” Marko said, adding that “geopolitics don’t seem to matter to markets until suddenly they do.”