A Chart Demonstrating How FED Policy Causes Volatility
During a discussion with a contact, I pointed out that watching the FED is one of the easy ways to forecast volatility.
Being specific here, FED policy on interest rates is a key predictor of market volatility.
To summarise, Federal Reserve interest rates induce tightening at institutions. This in turn causes credit crunches out in the real markets as institutions begin to tighten standards.
When this feeds through into the consumer level, this causes volatility n the real markets and hence we see peaks of the market-based components of credit conditions (I.e. the institutional banks and companies) coinciding very neatly with the VIX.
There are many reasons for this.
Firstly, tight credit conditions mean less margin is available.
This should be self-explanatory.
Secondly, it means that ultimately consumers are not able to consume on the level that they previously did and this of course hits institutions in their balance sheets.
As a third-order consequence, it can often mean that it becomes difficult to roll debt and service debt and this can sometimes force the selling of assets to meet short-term cashflow requirements.
A lot of the time, this means selling bonds and equities.
We can see that when the FED begins tightening, the market-based institutions begin tightening a few months to a couple of years later.
The FED's interest rates therefore clearly front-run interest rates and credit conditions out in the real world.
And thus, because these credit conditions are correlated to the VIX, the FED's activity is a clear predictor of big spikes in the VIX (As well as potential downside in the vix).
Being specific here, FED policy on interest rates is a key predictor of market volatility.
To summarise, Federal Reserve interest rates induce tightening at institutions. This in turn causes credit crunches out in the real markets as institutions begin to tighten standards.
When this feeds through into the consumer level, this causes volatility n the real markets and hence we see peaks of the market-based components of credit conditions (I.e. the institutional banks and companies) coinciding very neatly with the VIX.
There are many reasons for this.
Firstly, tight credit conditions mean less margin is available.
This should be self-explanatory.
Secondly, it means that ultimately consumers are not able to consume on the level that they previously did and this of course hits institutions in their balance sheets.
As a third-order consequence, it can often mean that it becomes difficult to roll debt and service debt and this can sometimes force the selling of assets to meet short-term cashflow requirements.
A lot of the time, this means selling bonds and equities.
We can see that when the FED begins tightening, the market-based institutions begin tightening a few months to a couple of years later.
The FED's interest rates therefore clearly front-run interest rates and credit conditions out in the real world.
And thus, because these credit conditions are correlated to the VIX, the FED's activity is a clear predictor of big spikes in the VIX (As well as potential downside in the vix).
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