A return to relative tranquility

This is a short note to highlight the significant decline in market volatility over the course of the past year.

Price volatility is often thought of as "fear" that stems from uncertainty. The Vix Index, technically defined as the implied volatility of equity options, is the most common measure of volatility in the stock market, while the MOVE Index uses the implied volatility of Treasury bond options. The expected and implied volatility of prices underlying each index is a key determinant of the price of related options contracts. Higher expected volatility drives the price of options higher, and vice versa. Since purchasing options contracts reduces and investor's risk, options are highly prized (and thus more expensive) during periods of market distress. During periods of relative calm, investors are less likely to purchase options, and thus their prices decline. 

Chart #1

Chart #1 compares the Vix Index (white line) to the MOVE Index (orange line). Not surprisingly, both tend to move in tandem, but not always to the same degree. The last significant increase in volatility occurred last Spring, when Trump shocked the world with huge tariffs on U.S. imports. As the chart shows, volatility has subsided meaningfully since the Spring peak, and it now approaches levels which in the past have been associated with relatively calm (and often optimistic) equity and bond markets. 

The current relatively low level of both volatility indices is in many ways equivalent to a market-based measure of investors' confidence or sentiment. The market has lost its fear of tariffs, as many have been reduced or eliminated, and those remaining have failed to move the needle on inflation (as any economist worth his salt would have predicted) and do not appear to have posed much of an obstacle to growth (though I think the economy would be stronger without them). The principal value of Trump's tariffs derives from his ability to use them to achieve certain worthwhile objectives (e.g., reciprocal reductions in tariffs with some of our trading partners).

Improved confidence in the future is a good thing in and of itself, since it surely promotes greater saving and investment, which ultimately translate into more and better-paying jobs and higher living standards. On the other hand, finding good values in a period of tranquility becomes harder, and the market becomes more susceptible to disappointments. There's no free lunch, but things could certainly be a lot worse than they are today.