The calm before the (volatility) storm (VIX; VXX; XIV)

Nice catch at FT Alphaville:

We ♥ this note from Bank of America Merrill Lynch’s Ruslan Bikbov and Priya Misra.
It’s on a subject dear to our own hearts here on FT Alphaville — the curious case of persistently low volatility and the idea that it might be masking systemic risk. It also weaves together a plethora of other themes — massive short volatility positions, search for yield, correlation, LTCM – we’ve touched on.
So sit back, think of stubbornly low volatility measures like the Vix, and read on:

The Chart of the Day shows that our measure of average cross-asset correlation has notably increased. This measure is a weighted-average correlation of the 10y US swap rate with the S&P 500, oil and DXY dollar index. The rise in correlations is evident in almost all individual cross-asset pairs. For example, the three-month correlation between 10y and S&P increased to 64% (1.7 standard deviation above its historical mean). In the Chart of the Day, a positive value corresponds to a risk-on/ risk-off trading environment. Days when rates increase tend to coincide with the rallies in risky assets and weaker US dollar, while days when rates decline tend to go along with sell-offs in risky assets and dollar strengthening.

It is very unusual, however, to see high levels of cross-asset correlation together with declining volatility.

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