WASHINGTON May 30 Low financial market
volatility has crept onto the list of concerns weighing on
officials at the Federal Reserve.
While the labor market and inflation dominate the Fed's
thinking on the economy, officials fret investor complacency
could sow the seeds for disruptive market moves that could
undermine the recovery.
In the Fed's eyes, a lot of uncertainty surrounds forecasts
for one of the strongest years of economic growth since the
recession ended, but investors appear to have priced assets for
"Volatility in the markets right now is unusually low," New
York Federal Reserve Bank President William Dudley said last
week. "I am nervous that people are taking too much comfort in
this low-volatility period and as a consequence of that, taking
The worry is in part a result of the Fed's own doing, as
more than five years of highly accommodative monetary policy
established a calm even in the face of choppy economic gains.
"It is easy to envision a scenario of tragic irony taking
shape," Jones Trading said in a research note. "The Fed has
lifted stability to the equivalent status of monetary policy at
a time when markets have never 'appeared' more stable."
The CBOE Volatility index, or VIX, is hovering near
lows not seen since March 2013, and is down 16 percent this
month alone. Volatility is low across stock, bond, foreign
exchange and commodity markets.
The concern shared by Fed officials is that low volatility
is encouraging investors to increase borrowing and load up on
risk with bets that could go bad quickly if the economy does not
perform as expected.
To some investors, the lack of volatility is surprising
given that the Fed is pulling back on its economic stimulus. But
the level of the VIX is just one piece of a confusing market
Many traders had expected U.S. bond yields would
rise this year on a recovering economy and on a Fed that is
taking its foot off the gas. The Fed has done as expected, but
U.S. yields have fallen - another potential sign of investor
comfort, at least with regard to the outlook for interest rate
Not everyone, however, sees the calm as concerning.
"Historically low volatility might be viewed by some as a
harbinger of doom," Bespoke Investment Group said in a research
note last week. "That isn't always the case."
Even so, Bespoke said it was not clear whether the VIX was
JPMorgan economist Michael Feroli and Anil Kashyap of the
University of Chicago believe the risk of a market shock is real
as the Fed unwinds its extraordinarily easy monetary policy.
"Our results suggest that bond markets could experience
another tantrum," they said in a paper released jointly with two
other researchers in February.
(Reporting by Michael Flaherty; Editing by Nick Zieminski)