(Bloomberg) — Across equity, bond and currency markets, gauges of volatility are slumping to their lowest levels of the year.
The Cboe Volatility Index, which measures the expected 30-day volatility for the S&P 500 — and dubbed Wall Street’s fear gauge — just fell to its lowest since December. A similar index for global currencies is the weakest in a year, while a gauge for US Treasuries is at levels last seen in early 2022.
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It might seem jarring that markets are pricing a limited chance of swings given a backdrop that’s littered with risk, from geopolitical tensions and sticky inflation to US President Donald Trump’s threats to the Federal Reserve’s independence. But dig a little deeper, and the moves start to stack up.
For starters, there’s “a lot of cash sitting on the sidelines,” said Mohit Kumar, chief economist at Jefferies International. That means plenty of investors are ready to snap up assets at lower prices, damping any selloffs before they really get going.
Then there’s the global economy, which seems far from sinking into the recession that many feared was inevitable when Trump moved to reshape global trade in April, triggering weeks of wild price swings.
Indeed, the US President has walked back from his most extreme tariffs threats, stoking investor confidence that he will ultimately always relent after aggressive posturing. That strategy — which analysts and strategists call “TACO” for “Trump Always Chickens Out” — mean investors have stepped in for fear of missing out on a rally.
Investors “realize that they’re watching the market go up,” said Guy Miller, chief market strategist and head of macroeconomics at Zurich. “There are still a lot of risks out there, but they feel they have to participate in this.”
To be sure, markets have seen bouts of turbulence this month. The VIX reached nearly 22 points intra-day on worse-than-expected payrolls data and tariffs, but it’s already displaying the pattern that options traders are accustomed to – fast reversal to lower levels.
The latest retreat came this week as the S&P 500 notched a fresh record high on Tuesday afternoon, with soothing inflation data boosting bets for a Fed interest-rate cut. In contrast to earlier this year, when even one cut was in doubt, money markets are now fully pricing two-quarter point reductions and a chance of a third by year-end.
That prospect of a gradual decline in borrowing costs is a key factor suppressing swings in the rates market, said Michael Sneyd, head of cross-asset and macro quantitative strategy at BNP Paribas SA. And volatility is unlikely to increase sharply unless labor data start to weaken more significantly, spurring expectations for multiple half-point cuts from the Fed.
“There’s starting to be a probability of that priced in, but not enough to impact the main vol pricing,” Sneyd added.
What Bloomberg strategists say…
“The message from markets is almost defiant. And yet, we’re still talking about potential stagflation, policy mistakes, or unforeseen shocks borne from the White House. If these risks are real, markets don’t seem to care. It’s difficult to discern whether this is just a temporary lull that we can chalk up to “summer doldrums.”
— Brendan Fagan, strategist in New York. Read the full note here.
Still, others have sounded an alarm over potential complacency. In Trump’s first term, the VIX index slid below 10 to a record low in late 2017, before spiking to hit 50 the following year.
Salman Ahmed, global head of macro and strategic asset allocation at Fidelity International, warns that investors must be prepared as markets enter a “phase of potential disruption.” The firm puts the chance of a US-led cyclical recession at 20% as the impact of higher tariffs seeps through the economy.
Meanwhile, Washington’s rising debt burden and spending levels may also force the Fed to adopt unusual measures such as yield curve control, he added. That would likely send tremors through the US Treasury market as bond prices become distorted.
“The US is entering a phase of fiscal dominance, where government spending programmes increasingly overshadow monetary policy,” Ahmed said. “How the Fed responds in this environment will be critical for market stability.”
There’s also a seasonal element to the decline in the volatility indexes, with investors typically less inclined to take on risk in the summer months. But according to BNP Paribas’ Sneyd, there are signs that markets are positioning for bigger price swings around specific events such as the next US payrolls report or earnings for Nvidia Corp., the chip-maker at the heart of the AI boom.
“We’re likely to see some vol buying going into the events of September,” he said.
–With assistance from Christian Dass, Sujata Rao and David Marino.
(Updates with additional comment from paragraph 10.)
