Volatility in the US equity market has retreated to its lowest level since early October as a pledge from the Federal Reserve to be patient with potential future interest rate rises and flexible with its balance sheet policy have soothed markets.
The decline means the gauge has now retraced most of the spike from the December quarter when remarks by Fed chairman Jay Powell about a likely need for further rate rises triggered a violent stock market sell-off.
The Cboe’s volatility index (.VIX), or Vix, was down 1.9 per cent at a reading of 15.83, which was its first time trading below 16 since December 3. At today’s session low of 15.78, the Vix reached its lowest since October 9.
Volatility in US Treasuries has also declined, with the Merrill Lynch Move Index that tracks one-month T-bills, also trading around its lowest level since early October.
One week after the Fed on September 26 lifted interest rates for the third time in 2018, Mr Powell said in a speech on October 3 that “interest rates are still low by historical standards, and they remain just below the broad range of estimates of the level that would be neutral for the economy”. The neutral rate is one that neither helps nor hinders economic growth.
The ‘long way from neutral’ remarks spooked markets, which took the view that not only would the US central bank proceed with another rate rise in December (which it ultimately did) but would come good on its own forecast to lifting borrowing costs three times this year.
The prospect of rapidly rising rates stirred concerns of US economic growth being throttled, and also prompted investors to dump growth-oriented tech stocks over subsequent months, which themselves were starting to paint outlooks of slowing global demand.
By late December, the Vix, popularly referred to as Wall Street’s fear gauge, reached intraday levels just above 35, the highest they had been since the volatility-induced sell-off of February last year.
Last week, the Fed staged a veritable about-turn as it put further rate rises on hold, citing tepid inflation and risks to global economic growth, as well as playing down concerns that the unwinding of its balance sheet would continue at an “autopilot” pace.
Although the move has raised eyebrows among Fed watchers, it has been welcomed by markets, which rallied on the shift, and tamped down expectations for market volatility. That was the cherry on top of a 7.9 per cent gain for the S&P 500 (.SPX) last month, which represented its best start to a year since 1987 and one of its top-10 biggest Januaries on record.
The Vix aims to measure the implied volatility of the US stock market over the next 30 days, derived from the prices of options called puts and calls. It is structured so that if investors expect S&P 500 fluctuations to average 1 per cent a day for the next month, the Vix level is about 20 — roughly its long-run average.