Implied Equity Volatility Tumbles

by: Calafia Beach Pundit

This chart of the implied volatility of equity index options is sending a powerful message: The market's level of fear and uncertainty has declined significantly in recent weeks and months. We can only guess at the reasons for this, but the improved outlook is not just a function of today's massive ECB refinancing operation or yesterday's strong housing starts.

I would argue that there is a whole host of developments that have brought more clarity and calm to the markets. Economic data have so far failed to reveal any economic collapse, despite the continued high level of stress in Eurozone financial markets (2-year swap spreads are still in nosebleed territory at 115 bps).

Markets have had 20 months to prepare for a Eurozone default, panicky investors have had plenty of time to take refuge, over-extended banks have had plenty of time to hedge themselves, and risk-loving hedge funds and distressed debt investors have had plenty of time to marshall their forces in eager anticipation of panic-driven sales.

The U.S. economy shows every sign of continuing to grow, albeit at a disappointingly slow rate. Corporate profits continue to be very strong. Central banks have embraced their role as lenders of last resort, and liquidity in most parts of the world remains abundant. Profligate government spending is meeting strong resistance almost everywhere.

If there is a single message here, it is that we are not on the cusp of the-end-of-the-world-as-we-know-it. Given how fearful the market has been, that's very good news.