The investment community is between major events this week. Last week we saw the Fed decision and drama surrounding the choice of the next Fed chair. Next week we see battle lines being drawn for the fiscal battles that have been brewing for months over a government shutdown and an increase in the debt ceiling.
Within this context, global financial markets are able to assess quantitatively just how nervous investors are looking into the future. We saw some interesting data this week, particularly how volatile some key exchange rates will be over the next few months. Today, "implied" volatility - based on pricing of certain foreign exchange contracts – is near some of its lowest levels since 2007. Interestingly, the same can be said of the VIX – the Chicago Board of Trade index that tracks the chills traders get over the S&P 500 for the next 30 days.
- This low volatility would not seem to make sense considering the shocks the markets had last week, and the extreme uncertainty surrounding what is happening in Washington. I see two primary reasons for the low volatility.
- The new easy money stance of the Fed does put it back in line with other major central banks, so within the foreign exchange markets at least, the Fed is no longer the lone (relative) hawk among the big central banks. Up until last week, volatility had been a bit elevated, but it dropped right after the decision.
Markets interpret the no taper decision of the Fed as just a pause in the eventual tightening story. It is certainly not a change in policy direction. Volatility related to tapering and tightening by the Fed will come, just not now.
My View: Markets are not stupid, and do not expect the next few months to be an easy breeze. Whatever the reason for low readings for volatility, they will change as the action in markets picks up very soon. We are just in the calm between storms.
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