"Risk can neither be created or destroyed, and repressing volatility in one place accentuates it in another."
Variant Perception Research, July 23, 2020
Fixed-income volatility, after a brief burst higher in March, has settled back down again. Currency and equity volatility also surged higher earlier this year, but have not fallen back so far, with the VIX remaining at the 90th percentile over the last five years. JPM’s currency vol index is at the 27th percentile, while the Move index of fixed-income volatility is only at its 13th percentile. The prospect of yield capping at the Fed is keeping a lid on fixed-income volatility. This is borne out with the US’s previous experience of yield capping between 1942 and 1951. The Fed capped both short and longer-term government yields, which led monthly volatility for 10y yields (the highest frequency data we can get from that period) to be very low, with it rising only after the Fed stopped capping yields as part of the Treasury-Fed Accord in 1951 (top-left chart). The policy also led to a persistent flattening of bond curves (top-right chart).
Risk can neither be created or destroyed, and repressing volatility in one place accentuates it in another. Other asset class vols will bear the full burden of adjustment from capital flows, which are likely to be boosted by high excess liquidity; indeed we see that higher FX vol is consistent with high excess liquidity (bottom-left chart). Also flatter yield curves generally point to equity volatility continuing to remain elevated (last chart).