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Now Even the Fed's Worried That Stock Volatility Is Too Low

Stock turbulence has been all but banished from the market.

By Dani Burger

(Bloomberg) --Add the Federal Reserve to the list of worriers about investor complacency as stocks set new records almost daily.

A few officials at the central bank “expressed concern that the low level of implied volatility in equity markets appeared inconsistent with the considerable uncertainty attending the outlook” for Donald Trump to deliver on pro-growth campaign policies, according to the minutes from the Fed’s meeting three weeks ago, which were released Wednesday.

Stock turbulence has been all but banished from the market. The Chicago Board Options Exchange Volatility Index, a gauge of investor anxiety also known as the VIX, has been unusually calm in recent months. It’s less than two points above its 15-year low, even as the S&P 500 Index catapults to new highs. The measure rose 1.5 percent Wednesday, the first time it’s posted back-to back gains this month.

Fed members join a choir of market observers who are scratching their heads over a consistently suppressed VIX. Sure, optimism for economic fundamentals could be putting a cap on market volatility. But others see more credence in the Fed’s explanation, where stocks appear to be plotting their own trajectory based on policy expectations under President Donald Trump.

Take Trump’s upcoming address to Congress on Feb. 28, where he’s expected to reveal details of his tax reform plans. It’s possible that any delays in implementing the program could shake the market from its calm, said John Canally, chief economic strategist at LPL Financial in Boston, particularly in light of the questions surrounding U.S. relations with global trade partners.

“I would agree with the Fed,” Canally said. “Everyone is wondering why equity market volatility is so low given the uncertainty out there. Take your pick. There’s the potential tax policies, overseas concerns, China.”

Rude Awakening
All of the quiet could make for a rude awakening, according to Paul Britton, founder of the $3.4 billion volatility hedge fund Capstone Investment Advisors.

Britton points to the disconnect in expected volatility for stocks versus other asset classes. The VIX fell to a 19-month low against a gauge of Treasury price swings in late January, while the current ratio between the two remains 15 percent below its average since the start of 2014, data compiled by Bloomberg show.

In the minutes, central bank officials voiced concern about the pace at which the U.S. equity market has advanced. Some believe that fast rising stock prices might “reflect investors’ anticipation of a boost to earnings from a cut in corporate taxes or more expansionary fiscal policy, which might not materialize,” according to the minutes. The S&P 500 has gained 3.7 percent this month, posting seven record closes in the process.

While it isn’t unusual for the Fed to comment on financial market conditions, taking a such a hyper-specific look at the stock market and volatility is notable, Canally said. Still, even if policy doesn’t play out to investors’ expectations, healthy market fundamentals should support any momentary pullback, he added.

“The economy is not in dire need of a tax cut, ” Canally said. “Corporate earnings are fine, and I’m fairly certain that a pullback will be bought, not sold.”

 

To contact the reporter on this story: Dani Burger in New York at [email protected] To contact the editors responsible for this story: Jeremy Herron at [email protected] Eric J. Weiner, Brendan Walsh

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