Short volatility positions are back at extreme levels once again, showing the growth of complacency among market participants. The more dovish than expected Fed has allowed volatility sellers to become more emboldened, and speculative VIX future positions are back up to net 40% short (top-left chart). Across all asset classes, volatility is falling. The top-right chart shows standardised cross-asset implied volatility (equity, fixed income, FX and gold), where we can see that volatility is back towards multi-year lows.

Investors are too complacent on the ability of the Fed to suppress volatility. The bottom-left chart shows that monetary policy works with a lag and that the effects of previous rate hikes will still be working their way through the economy. Real Fed Funds rates tend to lead realised equity volatility by about 2 years and suggests we are still in an environment where volatility will be biased higher. The last chart shows that the rolling correlation of equity hedge funds with the S&P has risen back up towards 90%, showing that equity hedge funds do not have differentiated exposures in aggregate. Given the high exposure of equity hedge funds to stock-market beta, it elevates the risk of these funds reducing risk in the event of a S&P drawdown, which could exacerbate market moves and increase volatility.

(Click on image to enlarge.)

Source: Bloomberg, Macrobond and Variant Perception