The financial world is familiar with volatility smiles and volatility smirks. This week we were treated to a volatility yawn.
Treasury and equity volatility declined all the way into the Federal Open Market Committee’s Wednesday-Thursday meeting as investors concluded that the FOMC would probably not raise the federal funds target rate – the FOMC had repeatedly voiced its concern about too little global growth and too little inflation. But all was not ho-hum on Thursday. A moment of excitement was evident around 2:30 p.m. ET, after the FOMC’s 2:00 p.m. ET announcement that it had left rates unchanged, when the CBOE Volatility Index (VIX) plunged for an hour to a value of 18. The VIX Index later regained its ground and ended the day at 21.14, still much higher than before China’s economic crisis became apparent in June.
The CBOE/CBOT 10-Year U.S. Treasury Note Volatility Index (TYVIX) also declined, but did not bounce back like VIX, and closed at a value of 5.20.
The shifts and turns of the term structure of VIX futures convey the tribulations of the stock market over the past two months. It took two months before U.S. equities fully reacted to the June 2015 news of deteriorating economic conditions in China. The stock market plunged on August 24, turning the contango of the VIX term structure to strong backwardation. After yesterday’s FOMC decision not to increase the target Fed Fund rate, the term structure is now in mild backwardation.
Figure 3. Weekly Statistical Update, Sep 18 2015