Where Fed Has and Hasn’t Contained Volatility

Are credit spreads signaling a sluggish economic recovery?

Erik Norland, Senior Economist, CME Group
Originally published in the June | July 2020 issue

Implied volatility has receded substantially across a range of markets including government bonds, equities, currencies and precious metals since peaking in March. In some asset classes, implied volatility has returned to the historical lows of the pre-pandemic period. For many others, while implied volatility is well off its March highs, it remains notable. 

Implied volatility has returned to previous lows on the US government bond yield curve for maturities of 10 years and less (Figures 1 and 2). By early June, 2Y, 5Y and 10Y bond options traded close to levels last seen in December and January before the pandemic reached US shores. This is not surprising given that the Federal Reserve (Fed) controls short-term interest rates directly. By signalling that it intends to keep interest rates low as the economy recovers, the Fed has reigned in short-term interest rate volatility by reassuring investors that rate hikes are not at hand. Additionally, the Fed’s aggressive buying of government bonds via quantitative easing (QE) has also helped to contain volatility. 

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