* Market volatility down in Treasuries, stocks, dollar
* Low volatility despite Fed taper talk, data surprises
* Investors confident that Fed won't withdraw liquidity soon
By Jamie McGeever
LONDON, Nov 17 For all the fevered speculation
about when the Federal Reserve will begin scaling back its
monetary stimulus, market volatility has been taking a leisurely
nap, suggesting investors see no major shocks on the horizon to
derail their bets.
Low market volatility is a sign markets expect no "taper"
any time soon, or that they are steeled for a reduction in the
pace of the Fed's bond-buying if it comes.
The sting of the taper has been gradually sucked out of
markets since the Fed's surprise decision not to start
withdrawing stimulus in September.
Since then, implied volatility in U.S. Treasuries, stocks
and key dollar exchange rates has sunk close to its lowest in
months, or in some cases years.
This might come as a surprise, given the noise surrounding
the latest relatively upbeat U.S. employment and economic growth
figures and the keenly awaited congressional testimony from Fed
Chair-elect Janet Yellen last Thursday.
But the Fed's $85 billion-a-month asset purchase programme
trumps everything, and as long as the liquidity taps are open,
the economic data will only have a real impact on markets if it
changes the Fed's thinking.
"We're not trying to follow the twists and turns of the very
short-term investment cycle," said Kevin Gardiner, head of
global investment strategy at Barclays Wealth in London.
The same goes for data or Fed commentary, he said. Only if
they "dramatically changed" the Fed's policy outlook would he
consider altering his strategy.
Market pricing and indicators suggest he's not alone. Wall
Street last week posted record highs on an almost daily basis,
and the S&P 500 and Dow Jones Industrials have
risen for six consecutive weeks.
This has been fuelled by a collapse in volatility from the
unusually high levels around the U.S. debt ceiling and
government shutdown crisis in early October. The VIX index
of implied volatility for the S&P 500 fell to a
three-month low on Thursday.
It's a similar story in the U.S. bond market. The 'Mermove'
index of three-month implied volatility on
Treasuries has almost halved since early September.
The following chart shows that since mid-2011, the
correlation between U.S. economic surprises and two-year
Treasury yields has completely broken down:
The ebb and flow of data surprises - both positive and
negative - has had virtually no bearing on yields, which have
remained at historic lows thanks to the trillions of dollars of
liquidity and zero interest rates from the Fed.
Currency traders are even more sanguine. One-month implied
volatility on the euro/dollar exchange rate posted its
lowest daily close on Thursday since 2007.
"The foreign exchange market is digesting signs that the
period of peak liquidity will remain in place for the
foreseeable future," Brown Brothers Harriman said in a note on
At her nomination hearing on Capitol Hill On Thursday,
Yellen said it was "imperative" that the Fed did all it could
to promote a "very strong recovery".
That wouldn't have surprised anyone. But what might have
raised a few eyebrows was her assertion that she wouldn't rule
out using monetary policy to address asset price
"misalignments", otherwise known as "bubbles".
This marked a departure from former Fed chief Alan Greenspan
and current incumbent Ben Bernanke. Both said it was virtually
impossible to detect bubbles in asset markets and was not the
Fed's business to deal with them.
But tightening monetary policy to cool asset markets is less
likely than tightening to meet the Fed's mandate on employment
or inflation, which remain well short of the stated goals.
In that light, the taper, when it comes, will be a "slow,
careful withdrawal of stimulus", reckons Bank of America-Merrill
Lynch, forecasting another 10 percent rise in the S&P 500 over
the next 12 months even as the Fed exits.
"Fear not the Fed," said the bank's U.S. economist Ethan