Volatility lowest since ’07 in stocks, bonds, currency

April 2 (Bloomberg) -- Markets for equities, bonds and currencies are the calmest they’ve been since 2007, and that’s making some investors nervous.

Options that protect against Standard & Poor’s 500 Index losses plunged 64% in the last two quarters, the most ever, data compiled by Bloomberg show. Interest-rate volatility is near a five-year low, while demand for hedges against extreme moves in the dollar is close to the weakest since 2008. Bank of America Corp.’s Market Risk cross-asset volatility index reached a level not seen since November 2007.

Becalmed markets have fooled investors before. The Chicago Board Options Exchange Volatility Index fell to a 13-year low of 9.89 in January 2007 before the financial crisis of 2008 wiped $37 trillion from share prices worldwide. As the gauge of options prices slipped within 5 points of that level last week following a 28% S&P 500 rally, demand has risen fivefold for exchange-traded products whose value increases should volatility rebound.

“Nobody is scared right now, but the fear will come back,” Sean Heron, who manages options strategies at Glenmede Trust Co., said in a March 30 phone interview. The Philadelphia-based firm oversees about $20 billion. “All bets are off as soon as we get beyond the next three months. Europe could rear its ugly head again and it’s an election year in the U.S.”

Financial Stress

Bank of America Merrill Lynch’s indicator of cross-asset volatility, a component of their Global Financial Stress Index, fell to minus 0.41 on March 29, down from a positive reading of 0.28 at the beginning of the year. It touched minus 0.48 on March 2, its lowest level since November 2007, just before the U.S. economy was about to enter an 18-month recession and a month after the S&P 500 reached a record high.

The index is a measure of future price swings implied by option markets in global equities, interest rates, currencies and commodities. A negative number means lower-than-normal volatility expectations based on data going back to 2000.

“The rally in risk assets combined with the liquidity support provided to the market by central banks have acted to depress volatility,” Benjamin Bowler, San Francisco-based head of global equity derivatives research at Bank of America Corp., said in a March 29 phone interview. “If the recent strength of the U.S. economy begins to fade and markets roll over, then I would expect to see a rise in volatility.”

The VIX averaged 18.04 from January through April 2011, falling to 14.62 on April 28, a day before the S&P 500 peaked and began a 19% decline that lasted until Oct. 3. The S&P 500 moved 1.3 percent a day from April through December, compared with a 50-year average of 0.6% before the collapse of Lehman Brothers Holdings Inc. in 2008.

Liquidity Injections

Investors have been appeased so far in 2012 as central banks from Europe to the U.S. and Asia try to speed the recovery from the first global recession since World War II. The Federal Reserve pledged to keep rates near zero through at least late 2014, while the European Central Bank gave banks more than $1 trillion of three-year loans. The Bank of Japan unexpectedly added 10 trillion yen ($120 billion) to an asset-purchase program in February.

Improvements in U.S. payrolls and consumer confidence pushed the S&P 500 to its biggest first-quarter rally since 1998. It advanced 12 percent in 2012 to 1,408.47 on March 30. The VIX slid a record 66 percent since its Oct. 3 high to 15.5 on March 30, below its 22-year historical average of 20.54. The gauge, which touched its lowest level since June 2007 on March 26, was up 6.9% to 16.57 as of 9:38 a.m. in New York today. Europe’s VStoxx Index fell 0.1% to 22.52.

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