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ChartBrief 85 - Are we all wrong about volatility?

A number of commentators have pointed out the divergence between economic policy uncertainty indexes and the VIX or equity volatility. We decided to take a global view on the matter, by looking at a global volatility index and global economic policy uncertainty index, and the relationship is much as you would expect. But there are a couple of very important observations to highlight.

First, consider the gap between policy uncertainty and the volatility index, the usual conclusion is that volatility is likely to head higher as a result of elevated policy uncertainty. However, it is quite possible that this interpretation is backwards. In recent months volatility has been falling and so too has policy uncertainty. It may well be that improved economic conditions and calmer and well-performing markets are actually creating the conditions that have allowed for lower economic policy uncertainty. While our view is generally to look at the volatility index as a contrarian indicator, lower volatility can be helpful for confidence. So continue to watch the gap, but think differently.

Globally economic policy uncertainty appears to be fairly well correlated with equity market volatility. However it is not 100% clear whether or which one leads the other.

Globally equity volatility is trading at very low levels. This is generally a contrarian signal, however volatility can make things easier and improve confidence. In fact, history shows it's more risky when volatility is trending up rather than trending down.

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