It is extremely rare for equity and rate vols to diverge as much as they have for this long. I continue to think equity vols at these levels are a gift for constructing many different types of trading strategies. Below is 1m10y normal volatility versus the VIX.
This doesn’t mean the VIX will spike to 30. Equity vols are specific to the mix of companies in the index, and the best comparison for equity vols is credit spreads, and on this basis they are in line.
Another factor driving low equity vols is correlations are low. There are so many divergent stories, such as large cap vs. small caps, cyclicals vs. defensives, growth vs. value, AI vs. everything else, that they are offsetting each other’s volatility to result in lower index vol. Of course, we know that in a risk-off event, correlations spike to 1, and vols follow suit higher. Hard to see such a catalyst now, but they do come out of nowhere. A hawkish Fed next week would be such a catalyst if it materialized.
The more surprising market to me remains FX, where vols are falling off a cliff. We are seeing significant divergences between economies, but currency markets are not pricing any divergent rate paths at all, so currencies are simply not moving much. This will change once cutting cycles begin around June.
Great time for cross-asset trading with such differences across markets.
Eventually mkt will likely again push back cut expectations (and out the curve) as Fed will reiterate that we need a little more time. It’s complicated as they don’t want to be caught in any political accusations and this makes any cuts beyond July hard to imagine. Suddenly, if growth, jobs and inflation keeps the pace, we will have a 24 without any cuts.
“This will change once cutting cycles begin around June. “
How high is your conviction on this?