Week Ahead: Why is volatility so low?

FOMC and volatility

Hey everyone,

I am working on the comprehensive macro report (see previous ones here: link and link) but wanted to provide a brief note for the week ahead. I also wanted to touch on this big-picture idea of volatility.

Also, be sure to check out the synthesis of all the research drops and primers. I aggregated them into this article for you:

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Main Event:

Alright, so the main event this week is FOMC. The market doesn’t really care about the hike as long as it comes in line with expectations, it will all be about the dot plot and Powell’s rhetoric.

I don’t think the dot plot will show any major changes. I think the main thing to look for is Powell trying to use rhetoric that tells the market they are not cutting in 2024.

I have been running a trade in connection with this and we are in the money:

Big picture, I am not bullish duration (TLT as a proxy). The time will come but we aren’t there yet. If anything I am probably shorting TLT on any major spikes.

The interesting thing about this environment is that volatility is so low. Here is a chart of implied volatility across FX, bonds, equities, and HYG:

What we can see is that volatility has only dropped since the SVB crisis. Those traders who specifically rely on higher variance regimes to make their money are struggling a lot right now. There are a lot of trades that I am running where I might get the view right but the size of moves just isn’t big enough for me to make a ton of money.

The one thing that is up A TON is the Simplify Volatility Premia ETF (ticker: SVOL). This ETF basically shorts vol without exposure to the tails:

You can see implied vol across all major assets is incredibly low. I mentioned in a recent video (link) that once you have a change in correlations with expanding implied volatility, a regime shift is likely to occur. We aren’t seeing that right now though.

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Conclusion:

I will end by saying this, some people absolutely thrive in higher volatility environments. This applies to markets and even other domains. There are some people who are at their best when chaos and stress are at an extreme. The problem is when those types of people are put into calm environments, it is really difficult to adjust. The inverse is true for people who thrive in stable environments. The goal is to effectively moderate between them and really push your edge when you are able.

Is this a character trade to develop or intrinsic to the person? That is a question for another time but what I would say is make sure to know how aggressive you should be acting when you align with your environment.

Always stay in the fight.

Thanks for reading!