Figure 1 looks like a piece of modern art. It represents three successive iterations of the VIX- yield curve cycle, a phenomenon that has persisted  is easily understood when it’s broken down into the following four-stage cycle:  (upward slope), equity volatility is relatively high.


1. Early-stage recovery: yield curve remains steep, equity volatility begins to fall.


2. Mid-stage expansion: the yield curve starts to 


Source: Bloomberg Professional (GB3, USGG30YR and VIX), CME Economic Research Calculations


3. Late-stage expansion: yield curve becomes  recession dominate investor behaviour.


The VIX is the index of implied volatility on S&P 500® options and its daily time series is extraordinarily choppy. To clarify its relationship with the yield curve, we smooth them both by taking a two year (500-business day) moving average and then put the results into an “X to Y” scatterplot. The result is consistent counter-clockwise motion.


From our starting point in a recession, the Fed has responded to the economic downturn with much lower short-term rates. Steep, upward sloping yield curves with short-term rates much lower than long-term bond yields eventually are associated with an economic recovery and lower volatility. A sustained economic expansion, with low equity-market volatility enables the Fed to remove  (i.e., short-term rates moving higher with stable  curve environment is associated with an economic downturn and massive correction in the equity and credit markets which sends volatility soaring. High volatility and a crashing economy force the Fed to lower short-term rates and ease policy in order to assist in generating an economic recovery. Rinse. Repeat. (Figures 2, 3, 4).


Currently, markets are in a phase that resembles the    at low levels. The Fed and its peers abroad will  and tighten quickly (despite a lack of evidence of  later this decade. If they go slow, low volatility and economic growth could persist into the 2020s. As such, keep your eyes on the central banks, especially the Fed.


Erik Norland E: erik.norland@cmegroup.com Source: Bloomberg Professional (GB3, USGG30YR and VIX), CME Economic Research Calculations Figure 2: The 1990-1999 VIX-Yield Curve Cycle


Figure 1: Weirdest Chart Ever - Yield Curve-VIX Cycle


Source: Bloomberg Professional (GB3, USGG30Y and VIX), CME Economic Research Calculations Figure 3: The 2000-2008 VIX-Yield Curve Cycle


Source: Bloomberg Professional (GB3, USGG30YR and VIX), CME Economic Research Calculations Figure 4: The Current VIX-Yield Curve Cycle


25 | ADMISI - The Ghost In The Machine | January/February 2018


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