Central Banks Divergence
This summer, the major central banks around the globe have started to head in different directions as macroeconomic conditions change. In Europe, the European Central Bank (ECB) continues to keep easing as well as maintain 0.0 percent interest rates for members (Trading Economics). The ECB will remain purchasing €60 billion until the end of December at the minimum (Trading Economics). Continuing within the European theatre, the Bank of England (BOE) had a split decision to keep interest rates at 25 basis points even with rising interest rates from 0 percent in January 2016 to 2.9 percent in June 2017 (Trading Economics). The BOE diverged from the ECB by discontinuing quantitative easing earlier this year (Trading Economics).
In the Far East, the Bank of Japan (BOJ), lines up similarly to the ECB. The BOJ continues to keep short term interest rates at -10 basis points, and has continued to increase its balance sheet. Japan is also trying to preserve 10 year interest rates target at 0 percent (Trading Economics). Japan’s policymakers continue to target 2 percent inflation, yet indicators show inflation at .4 percent (Trading Economics).
While the other major central banks continue to ride this ship of easing with low interest rates, the Federal Reserve has decided to march in a different direction. According to the Federal Open Market Committee (FOMC), the inflationary and labor conditions of the United States accommodate the raise for interest rates (Federal Reserve). The short term target interest rate increased 25 basis points from 1.00 percent to 1.25 percent (Federal Reserve). The other substantial policy change by the FOMC is reducing the balance sheet. This “normalization” policy will start soon, with a $6 billion per month initially and reaching $30 billion per month over a 12 month period (Federal Reserve).
Mid-Year Volatility Snapshot
This year has been quite steady for many investors in terms of low volatility. The past six months have seen one of the lowest movements in the market (Chan). As of last week, the VIX stood at 9.36. To put this in context, the VIX has only been lower than 10 in 1.19 percent of the time over the past 5 years (Chan). All of these occurrences have happened over the past 3 months. The average range over the past 5 years was 14.89, and peaking in August 2015 with speculation in European Debt Crisis (Chan).
This period of low volatility has kept the VIX futures curve in steep contango. Over the past month, the one month difference in futures hovered around 10 percent on average (Vix Central). The 7 month minus 4 month continued to climb over the past 3 months from 7 percent to 13.3 percent as of July 24, 2017 (Vix Central).
There is a lot of speculation into why volatility is low compared to historical ranges. One of the prevailing reasons for low realized volatility is the substantial inflows into equity index ETF’s (Bhansali). Retail investors have flocked towards equity markets after transitions from national elections. The other major reason for low volatility is volatility strategies have been profitable strategies for generating yield over time. The premiums received for selling options is quite high, and rolling over options month to month creates a yield enrichment for investment managers (Bhansali). Whatever the case may be for low volatility, it’s still prudent to look at other fundamental factors to analyze market forces in the future.
Compiled by the Camelot Portfolios Investment Committee
Darren Munn, CFA, Chief Investment Officer
Eric Kartman, Research
Drew Steinman, CPA, Trader/Research
Zach Hartenburg, Analyst
Frank Echelmeyer, MBA, CKA®, Advisor Consultant
-for Broker/Dealer and RIA use only-
Bhansali, Vineer. Why Is Volatility So Low And What Should We Do Now? May 2017. 2017.
Chan, Szu Ping. Debt crisis: as it happened - July 23, 2012. 23 July 2012. 2017.
Federal Reserve. Press Release. June 2017. 2017.
Trading Economics. Euro Area Interest Rate. July 2017. 2017.
Vix Central. Contango. 2017. 2017.
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