Expected and historical (realized) volatility are sending investors a puzzling signal. Because of the Iran conflict, intense oil price swings, and rising interest rates, the , or implied volatility (what options markets are pricing in as future fear), is elevated.
However, actual realized volatility has been much more subdued. That gap between the VIX and realized volatility is wider than historical norms, thus worth examining. The graph below shows the difference between the VIX and realized volatility, measured in standard deviations (Sigma). Currently, the gap is over two sigma’s, a somewhat rare event.
The bearish interpretation is that the VIX is telling the truth and realized volatility is the lie. Options markets are pricing in risks that the equity market has not yet acknowledged. Simply, investors are paying a steep premium for protection against a shock that the market has not priced in. The bearish scenario is the gap closing with realized volatility catching up to implied volatility.
The bullish interpretation is that realized volatility is low because the underlying economy, despite higher , remains reasonably healthy and corporate earnings are unlikely to be significantly affected. Accordingly, the market is treating the Iranian conflict and surge in oil prices as a temporary disruption rather than a structural shock.
Thus, the bullish scenario is that the gap closes not through a realized volatility spike but through a gradual decline in implied volatility as the geopolitical situation stabilizes.
Both interpretations are defensible. When VIX, the market’s fear gauge, and actual volatility are telling different stories, paying close attention is warranted.
The Week Ahead
Despite the market closure for the Good Friday holiday, the BLS will release its employment report on Friday morning. After reporting a loss of 92k jobs last month, a rebound to +48k is expected. The is expected to tick up by 0.1% to 4.5%. on Tuesday and on Wednesday will provide further employment data.
The and surveys should provide some information on how the Iranian conflict is impacting business sentiment. for February will be released on Wednesday. As we share below, retail sales have been relatively flat since September. Bear in mind, this measure does not strip out ; thus, on a real basis, retail sales are declining at a 2-3% annualized rate. As a reminder, personal consumption accounts for roughtly 70% of GDP.
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Is The VIX Lying?
