Post-election, India markets witnessed a whopping 54% drop in volatility. Interestingly, low volatility has also caused the India Vix to drop from 28.3 on May 16th to 13.06 on Friday despite the sharp 190 points fall post the budget session. We looked into a wide range of instruments including equities, bonds, currencies, and commodities to pinpoint the cause behind the sudden drop in volatility. The one common phenomenon we noticed while studying major instruments is, markets across the globe have witnessed lower levels of implied volatility in options around the same time. As a matter of fact, the S&P 500 Vix Futures dropped to 14 from 20 while the CBOE Volatility Index slipped to 12 from 23.38 in the same time frame.
Is the Fed to Blame?
We dug a little deeper, and did a historical fact check and found out that Between 1990-91 markets were hit with high volatility as the US was hit with recession and the yield curves had flattened. The cause of the recession was an acute savings and loan crisis in the US. This forced the US investment bank Drexel Burnham Lambert into bankruptcy in February 1990. During the same period, US unemployment rates also rose to a mindboggling 8.2%. The Federal Reserve quickly stepped in and pushed interest rates down to 3% from 9.25%. This move worked wonders, between 1993-94, the yield curve steepened and volatility dropped. Around 1996, the Fed started raising rates again. It resulted in the Asian currency crisis in 1997 and markets were rocked with Volatility as Russia defaulted on its debts.
The S&P 500 Plunged 50% & Nasdaq Tanked 80%?
The tech bubble caused high volatility between in global markets between 2000-2002. Around this time, the Nasdaq plunged almost 80% and the S&P plunged 50% from 1552 and registered a low of 768. This time again the Fed was forced to slash rates from 6% to 1%. The market calmed down and Volatility eased.
Where Are We Standing Now?
Even when we looked into the massive recession and high market volatility in 2008, we noticed that it was primarily the aftermath of the Fed rate hike in 2004. Rates were pushed up to 5.25%.
We are at a critical juncture now; global markets are back at low volatility with flat yield curves. It’s time for the Fed to act. The current low volatility could mean, the markets are expecting massive turbulence if the Fed pins its hopes too long on the current unemployment rate. This could be a strong reason why President Trump is pushing the Fed to act before global markets drift into high volatility or a recession, ahead of the US election in 2020.