From the May investment comments of Provident Investment Management
To date, one could make the case that the return of volatility is the market story of the year. The Cboe Volatility Index, or VIX, spiked in February to a high of 50 before settling in at a level below 20. Despite the February surge, the current level of the VIX is roughly equivalent to its long-term average since it was created in 1993. Current levels on the VIX are roughly double where they were a year ago, underscoring how tranquil the market was in 2017. We are tracking in line with historical volatility despite the possibility of a trade war, missile strikes in Syria and a steady stream of market-moving tweets from the president. If the start to the year is any indication, a return to the abnormally low volatility we experienced a year ago appears unlikely.
When volatility first broke out in February, there was some thought it might help keep the Federal Reserve Board in check and prevent the three rate hikes initially anticipated for this year. This does not seem to be the case. The minutes from the March Fed meeting, where rates were raised by 0.25 percent, indicated a hawkish tilt.
The primary takeaway from the minutes was members’ belief in a stronger economic outlook and their increased confidence inflation would get back to 2 percent in the medium term. As a result, the path for rate hikes would “likely be slightly steeper than previously expected.” While the median policymaker at the Fed currently predicts a total of three rate hikes for the year, many analysts are now leaning toward four hikes as the more likely scenario.
Unsurprisingly, Fed policy has meaningful implications for short-term rates, though its ability to influence longer-term interest rates via rate hikes alone is less clear-cut. Long- term rates are generally driven by the economic outlook. The current environment featuring an uncertain longer-term outlook, due in part to trade policy, combined with recent Fed rate increases bear this out, as short-term rates have increased in relation to long-term rates.