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What Vol and the Dollar Have in Common

Not everything in the financial markets makes a whole lot of sense, but if you spend enough time staring at numbers, some of the pieces start to fit together.  In the last two days, volatility has absolutely collapsed.  With the announcement that the Fed will buy another $600 billion of assets it was truly a signal of “risk-on”!

VIX and the Futures Curve Tumble

If you have been a reader, you would know that I have been shorting VIX futures in different forms.  At 35% I thought it was crazy expensive and now it is more fairly priced.  Pretty soon it will probably be extremely cheap.  Volatility is linked to stock prices and liquidity.  If asset managers are chasing yield, risky assets, or any returns greater than a zero percent overnight rate, then asset prices become inflated.

What I posited quite a long time ago was that liquidity was very intertwined with volatility.  When the yield curve is steep, volatility declines on a lagged basis.  Since 1990, this seems like an absolute truth with more Fed intervention flooding the system with dollars.  It seems like we have run our course, but in reality the 10 year 2 year treasury spread is still historically high:

Do you see cycles of Monetary Intervention?

What is missing in this circular relationship is the actual lifeblood of the economy: the currency.  In the last few days the dollar has declined as equities have risen and vol has dropped.  In fact, if you look at the Dow Jones over the last few days, despite the rally, the real return in gold terms is flat:

Are you really winning?

If I could relay just one piece of information out of the many articles that I have written it would be this:  If you are not gaining in real terms, then you are the loser and someone is laughing at your expense.  When currencies fall, savers are punished and debtors are rewarded.  Despite these ugly statements, I expect it to continue because that is exactly the mandate that our Federal Reserve has embraced.

Posted in Derivatives, Economics, Educational, Markets, Politics, Trading Ideas.

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