A Bullish Case from Low Stock Market Volatility
Some people at the Fed leaked a story last week that Fed officials were worried about low market volatility. Volatility is indeed low, indicating that investors are complacent and also that they aren’t making any big bets on the economy or markets. This post makes an interesting case that the Fed leaked this story simply to see how investors would react. Tyler Cowen says that since markets didn’t really react to the story, investors truly are complacent and confident. They aren’t likely to panic at the next surprising bit of news.
There are some who argue that periods of low volatility are followed by market declines. Like so many rules of thumb, the data doesn’t support this. Sometimes low volatility leads to higher returns; sometimes it leads to lower returns. Don’t make a bet with your money on that rules of thumb unless you see a lot of data to support it.
So how does all this hang together? The Fed doesn’t want to crush the market, it just wants to test whether investors might in fact have some private information of their own. By “leaking” that it is worried about low volatility in the market, the Fed can see whether investors suddenly panic or whether they have a relatively firm basis for not feeling so worried.
And so far investors have not panicked, quite the contrary. The relatively sanguine beliefs of private investors thus seem to have a fair amount of depth. The Fed has nudged investors, to learn something about the shape of the response curve, and those investors have held their place or warmed to the data all the more.
