Wednesday, 11 October 2017

A Toxic Development: VIX Hits All-Time Low, Money Supply Volatility Hits 9-Year High

Why could this development be a toxic one? Because money supply volatility may lead to increased financial instability. In fact, it often precedes it.

In simple terms, the increases in money supply volatility, driven by sharp declines in the growth rate, that have taken place all year, and especially since March, represent increased risk for financial investors.

The VIX on the other hand, which a few days ago hit record lows, is indicating stock market participants do not expect much volatility.

In other words, the VIX could be sending the completely opposite message of that of the money supply volatility and may, especially at this stage with stock market prices and valuations at record highs, indicate a low degree of risk aversion or even complacency among investors.

With a surging money supply volatility and a record low VIX, this combination could be an especially toxic one for stocks if (when?) the money supply volatility triggers increased financial instability. This again would likely trigger increased stock market volatility and lower valuations which would, given the current level of the VIX, be completely unexpected. And, as we know, the stock market does not like negative surprises.

For more on the importance of money supply developments, see:

The Austrian Theory Of The Business Cycle - A Short Synthesis

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