the calm earlier than the storm? | USAEMALL.com

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Donald Trump’s weaponisation of uncertainty has been dialled up in his second term. The “will he, won’t he” prevarication over import duties, and other threats, has left companies and investors in a holding pattern. The observable befuddlement is now being picked up in various gauges of uncertainty.

The global economic policy uncertainty (EPU) index — which scans keywords in news media — jumped to a post-pandemic high in January:

Gold, which investors stockpile in times of uncertainty, hit an all-time high this week. And, the estimated US treasury term premia — the extra return investors demand to hold long-term bonds, in part due to uncertainty — has edged up to levels last seen when Trump started his first term.

Though commodities and bond traders are pricing in the uncertainty, US equity markets appear relatively calm.

One might expect measures of US stock market volatility, such as the Vix index, to also pick up at times like this. Indeed, the index tends to correlate with the EPU index.

But FTAV unearthed something curious. Right now the US EPU and Vix relationship has untethered somewhat. More interestingly, they did the same thing when Trump last entered office:

What gives? Leaving aside the debate over what the Vix really measures (for that, see below), there are a few possible explanations:

I) Equity investors might still be more in the “it’s just a negotiating strategy” camp. Perhaps holding shares, rather than actually being part of the potentially affected business itself makes Trump’s threats feel less tangible?

II) Traders may simply be too unsure to make any calls with conviction. Indeed, mainFT reported yesterday how analysts and investors have been imploring executives on earnings calls over how tariffs might impact companies.

A 2017 study by the University of Chicago of the then market volatility and economic uncertainty disconnect concluded that:

The US market does not respond to political uncertainty because political news coming from the new [Trump] administration has been unreliable and difficult for investors to interpret. 

III) As a wider market measure, Vix may be picking up on several things. The market perception of Trump’s growth-friendly policies for instance can offset volatility.

Charlie McElligott, managing director of cross-asset strategy at Nomura, adds another factor:

Policy uncertainty is not the only input into implied volatility. One “macro” catalyst for relatively “soft” volatility is that the Fed is telling us that they’re in wait-and-see mode on the next couple months of data, with the solid growth data . . . providing them the luxury of time, and not needing to make any policy rate moves. That’s another volatility killer.

These are all probably true to an extent, but no more comforting. In its last Global Financial Stability Report in October, the IMF warned about the disconnect between uncertainty and financial market volatility (which has grown following the US election):

The IMF’s message is reinforced by the VVIX — which measures investor expectations of swings in the Vix. That’s trading above its long-term average, suggesting investors are still wary that volatility could surge:

In sum, businesses and stock investors know things are potentially turbulent, but they don’t know what to do.

Trumpian uncertainty so far may then best be described as: shaken, not yet stirred.

Further Vixing:
— Can you trust the Vix? (Feb 2011)
— Why is the Vix so low? (March 2011)
— The volatility is out there (April 2011)
— More thoughts on what’s behind low volatility (April 2011)
— The calm before the (volatility) storm (June 2011)
— The Vix feedback loop, analysed (Jan 2012)
— A muted Vix (Aug 2012)
— End of a low-vol era? (April 2014)
— Does the VIX really measure volatility? (June 2014)
— Now that everyone’s a volatility seller… (Oct 2014)
— An abridged, illustrated history of volatility (March 2018)
— How a volatility virus infected Wall Street (April 2018)
— The surprisingly chilled bear market (Oct 2022)
— The ‘broken’ Vix (Jan 2023)
— An oral history of the fear index (Sept 2023)
— Are structured products to blame for suppressed volatility? (March 2024)
— Wall Street’s ‘fear gauge’ might be lying to you (Aug 2024)
— Volatility is being weird (Nov 2024)
— Etc.