MoneyBeat
By Steven Russolillo
May 15, 2014

Fear has left the building.

Wall Street’s so-called fear gauge has fallen so far that at least one market watcher wonders if structural, permanent changes have taken place in the market.

Stock-market volatility has tumbled in recent weeks, with the CBOE’s Volatility Index, the VIX, falling near its lowest level since the beginning of the year. It finished Wednesday at 12.17, down 43% from its high of 21.44 in February.

Minus a couple of brief spikes, the VIX has roughly remained around 14 for much of the year, well below its long-term average of about 20. Neither the geopolitical tensions in the Ukraine nor the two-month selloff in tech and small-cap stocks has made much of an impact on the broad market, with the Dow and S&P 500 perched near record levels.

“It is time to ask the question that dares not speak its name (at least on options desks): are we witnessing the death of volatility?” Nicholas Colas, chief market strategist at New York brokerage ConvergEx Group, asked in a research note this week. “Are we so accustomed to central bank intervention that any negative macro action has an equal and offsetting policy reaction?

The VIX has been low for the past few years, a far cry from what transpired in the second half of 2011 when it rose to the low 40s after the downgrade of the U.S. credit rating and during the European debt crisis. The fear gauge nearly hit 90 in October 2008 during the depths of the financial crisis.

“Current risk pricing in U.S. equities seems to point to something being ‘different’ this time around,” Mr. Colas said.

A low VIX comes as the stock market has marched back toward record territory. The S&P 500 is up 2.2% this year and has set 10 record highs in 2014. Despite steep drops concentrated in Internet, social media and biotech stocks, the broad averages have still managed to move higher for the year.

The VIX is calculated from the prices investors are willing to pay for options tied to the S&P 500. An decrease in demand for portfolio hedges can push those prices, and thus the price of the VIX, lower.

“We are not seeing any sort of major hedging activity,” Steven Rosen, head of single-stock and ETF volatility trading at Societe Generale in New York, told MoneyBeat earlier this week. Lately, for clients, buying insurance “just seems like a waste of money. Every selloff we have, you only see money come in to buy the market higher.”

To be sure, Mr. Colas of ConvergEx isn’t prepared to firmly declare volatility is dead. The best analogy for the current market environment, he said, is the sunny and 70-degree weather in Los Angeles.

“It’s not the weather in LA that will kill you; it’s the earthquakes,” Mr. Colas said. “Those are harder to predict, but you know they are coming.”

The same could be said for the next big market selloff.

Remarks before the Louisiana Bankers Association 114th Annual Convention and Expo
New Orleans, Louisiana · May 9, 2014

Monetary Policy Going Forward: De-Spiking the Punch Bowl 10 Ounces at a Time

Now, if you will indulge me, I want to speak of the direction of monetary policy from here onward.

The Federal Open Market Committee (FOMC) is in the process of winding down its massive purchases of Treasuries and mortgage-backed securities. At our last meeting, in recognition that the economy is improving and acknowledging that we have generated massive amounts of excess reserves among depository institutions operating in the U.S., we voted to reduce our purchases to a combined $45 billion per month, on the path to eliminating them at the earliest practicable date. Speaking only for myself as a voting member, barring some destabilizing development in the real economy that comes out of left field, I will continue to vote for the pace of reduction we have undertaken, reducing by $10 billion per meeting our purchases and eliminating them entirely at the October meeting with a final reduction of $15 billion.

I was not for this program, popularly known as QE3, to begin with. I doubted its efficacy and was convinced that the financial system already had sufficient liquidity to finance recovery without providing tinder for future inflation. But I lost that argument in the fall of 2012, and I am just happy that we will be rid of the program soon enough.

I am often asked why I do not support a more rapid deceleration of our purchases, given my agnosticism about their effectiveness and my concern that they might well be leading to froth in certain segments of the financial markets. The answer is an admission of reality: We juiced the trading and risk markets so extensively that they became somewhat addicted to our accommodation of their needs. You may remember the “taper tantrum” market operators threw last spring when we broached the idea of temperance. It went over about as big as would saying you wanted to ban Hurricanes and other happy-making libations here in New Orleans!