I freely admit to being a bit of a volatility nerd.

On my watchlist I have the real time data for the US fear Gauge index, the Vix. I check the level every few days, looking out for signs of impending chaos. And yet every day for most of the last year I’ve come away confused. Trump wins. Vix goes down. Worries about North Korea dropping a few nukes. Vix goes down. Aliens invade Australia. Vix goes down.

Trump wins. Vix goes down.

Worries about North Korea dropping a few nukes. Vix goes down.

Aliens invade Australia. Vix goes down.

OK, I made the last one up but you get my point. But something is definitely up with the Vix.

It is ‘becalmed’ as my sea faring cousin would put it. Or dead as a parrot according to my Python loving brother in law.

Basic facts: the average level of VIX for this year sits in the lowest 5% in history (since 1991) with the current level being in the lowest 1%. Furthermore, the low of 9.75 this year was the 5th lowest in history, a level last achieved in late 1993. The chart below from Sharescope puts it all in grisly detail. It shows the last two years VIX levels, with trend lines either side. Again, I don’t think you need me to repeat the general direction of these trend lines.

On one level, of course, there is no great mystery. Equities markets have been relatively quiet but also buoyant. Thus, Vix has been low. Problem solved. But this rather ignores the underlying reality. Something else ‘must be going on’ as my Corbyn loving niece would say!

One explanation relates to the specifics of the market in Vix options itself. The best explanation here comes from ETF Securities Head of Research James Butterfill. Here’s his recent take, in a blog, on what’s going on in the market for Vix options.

“ Since 2013 a worrying trend has arisen amongst a group of investors who are shorting the VIX. The subdued level of the VIX has likely been driven by investors, on the hunt for yield, motivated by years of loose monetary policy. The steep term structure gives these investors who are short the VIX a yield. According to the CFTC investors are holding record short positions – over 3x standard deviation from its historical range relative to long positions – suggesting shorting the VIX is an increasingly crowded trade.

“ We question how long this can last given the VIX is so low. We also remain concerned that an unwind of this trade will hurt, potentially prompting a VIX short squeeze and the resultant higher volatility prompting a risk asset sell-off. Timing a potential shift in sentiment is difficult although shorting the VIX will become increasingly less attractive every time the US Federal Reserve (FED) increases interest rates. The short VIX yield will, therefore, look increasingly less attractive as yields in other assets increase with rising interest rates. Conversely, an unexpected sharp move in equities or a significant political event could also precipitate an unwind in short VIX positioning.”

Butterfill suspects that investors are becoming much too complacent, especially given how high valuations have become in US equities. It’s a view that I have sympathy with.

But…but…but…I also think there is a deeper structural reason. My slightly conspiratorial side also can’t help but think that Vix might REMAIN low for a very long time. Why? Because interest rates will remain low and central banks are watching the vix as a warning signal. In this alternative world view, market volatility – or lack of it – is a simple function of central bank balance sheet expansion. Banks buy corporate bonds. This buying helps steady equity investor nerves. Vix remains low. Banks also watch VIX, so that if it pops, they buy more bonds. Problem solved.

Research analysts at London based house Cross Border tend to echo this line of reasoning. They also observe that the VIX is not the only volatility measure. Equivalent indexes track bond market volatility along the US yield curve (e.g. the MOVE index) and major currency-crosses (e.g. the CVIX index). Cross Border dubs these, for convenience, respectively, the BIX and FIX.

According to Cross Border :

The BIX, FIX and VIX indexes are: (1) persistent (i.e. they trend for long periods) and (2) they are highly correlated together. Their interaction is complex, but it can be uncovered from a simple Vector Auto-regression model (VAR). This shows Granger causality running from bond market shocks (BIX) to forex shocks (FIX) and to equity shocks (VIX). The VAR also confirms high autocorrelation or persistence for the BIX (e.g. parameter on the previous lagged value 0.852); the FIX (0.904) and the VIX (0.856). This is consistent with regime shifts from periods of high to low volatility.” The table below maps out these complex relationships in some simple correlation numbers.

I can’t say I’m any expert on auto regression models but I am inclined to agree with Cross Border’s bottom line:

“We conclude that a World characterised by: (1) Central Bank ‘Forward Guidance’ and (2) low credit growth, possibly induced by tighter regulation of banks, there is likely to be low volatility across most asset classes. This backdrop has characterised the last few years and slow policy rate movers and tightly regulated banks were also features of the 1950s and 1960s, when both the MOVE (74.6 vs 97.3) and VIX (12.2 vs 16.9) stood well below their entire period averages. For this backdrop to change, we must either see private sector credit growth jump higher and/or Central Bank policy actions deviate significantly away from prevailing market expectations. Such ‘shocks’ will trigger heightened market volatility. They will come, but until then, expect low volatility to continue.”

If you believe – as I do – that we are in a for a multi-decade low rates environment, then volatility could remain at subdued levels for a very, very long period of time indeed.

As I’ve said in this blog before, I fully expect US interest rates to get above 2% – and then come crashing down immediately. Overall, I believe we are in a sub 2.5% rates environment for the next few decades.

In this scenario, Vix as an index becomes increasingly irrelevant as a fear gauge. It’s also an increasingly impractical hedging tool.