Federal Funds Target Rate and Treasury Volatility
With 26 days left until the September 16th meeting of the Federal Reserve Open Market Committee, and signals for U.S. rates diverging amid continued China and Europe economic weakness, it is still uncertain whether the FOMC will lift the lid on the federal funds target rate (FFTR) on September 16 or later. The FOMC is concerned that a rate hike will stall the U.S. economy and market participants are concerned that a rate hike will depress Treasuries and increase volatility. So it’s is a good time to examine how the CBOE TYVIX Index and Volatility Index (VIX) have behaved after past changes in monetary policy.
To get a longer perspective, we plotted realized Treasury volatility as a proxy for TYIVX and realized S&P 500 volatility as a proxy for VIX. As illustrated in Figure 1 for TYVIX and VIX, expected and subsequent realized volatility are broadly in line.
Figure 1. Expected versus subsequent Realized Volatility, 10-Year Treasuries and S&P 500 Federal Fund Target Rate and Volatility
Figure 2 below shows the history of the federal funds target rate, versus Treasury volatility in the top panel and S&P 500 volatility in the bottom panel. Real gross domestic product (GDP) growth serves as backdrop in the top panel to remind us just how weak real GDP growth remained while the federal funds target rate sank lower and lower.
Highlights from Figure 2 include:
- a) With a few pauses, the FFTR began its descent to a zero interest rate policy (ZIRP) in 1989 (ZIRP is a bit of an exaggeration, as the Federal Reserve has held the federal funds target rate at 25 basis points since January 2009), decreasing from 5% to .25%.
- b) Compared to the surge around 1980, and its after effects until 1989, realized Treasury volatility has been relatively low, trading in a range of 3 to 9 percentage points. Prior to 1980, Treasury volatility was lower than today. Hence today’s Treasury volatility, and TYVIX by extension, is in a mid-range. Note how flares in Treasury volatility have tended to occur when the FFTR decreased (1993, 2003 and 2008), not when it increased.
- c) S&P 500 volatility is in a low to middle range compared to prior history. Similar to Treasury volatility, flares in S&P 500 volatility have tended to follow decreases in the FFTR.
Figure 2. Fed Fund Target Rate, Treasury Volatility, S&P 500 Volatility and Real GDP Growth
Weekly Update on Volatility and Volatility Futures
Continued concerns over the Chinese economy depressed stock markets and increased the TYVIX Index to 5.91. Futures on TYVIX Index followed , but the star of the show is the VIX Index, which reached 23.53 by 11 a.m. ET on Friday. The VIX Index is now well above its historical median since 2003, but the TYVIX Index has a little way to go. Currency volatility is also up, especially JYVIX.
Post written by Catherine Shalen, CBOE Research