From the stabilization in equities to corporate credit spreads and the VIX both stopping short of crisis levels, markets have been pointing to this benign outcome… but with the market now expecting rate cuts in 2023 in defiance of Fed assurances to the contrary, the stage could be set for future volatility.

Rather than restraining like a seatbelt, the VIX tends to deploy on contact like an airbag and a lack of deployment under present conditions says nothing about its future potential. In fact, from today’s bargain levels and with the unknown impact of Fed rate hikes lurking, we believe VIX exposures have rarely been more attractive.

Given the historical tendency for major VIX spikes following similar turns in monetary policy, this is perhaps the most critical divergence in markets today. From currently modest VIX levels and considering the magnitude of this year’s rate adjustment, its resolution may not pass quietly.

In cycles that often take years to play out, the ebbs and flows of monetary policy give rise to business cycles that create the large VIX “loops” observed throughout its history. Were it to hold, the year’s closing high of 36.45 would represent one of the lowest bear market peaks in VIX history, suggesting that the current loop is not yet complete.

Taken together, this year’s price messages seem to be acknowledging elevated risk while also anticipating a market-friendly central bank “downshift” (slower pace of rate hikes) and eventually a “pivot” (rate cuts) as inflation recedes.