"This Has Never Happened Before": Goldman Warns Low-Vol Regime Is In Jeopardy

Picking up on something we first noted over a month ago, and following last week's VIX fireworks, this morning Goldman's Ian Wright looks at the rapid changes in the volatility landscape - beyond just last Thursday's near historic surge in the VIX which shot up from single digits to over 17 in 48 hours - and points out something that has never been observed before: the ratio of VVIX to VIX, or the vol of vol relative to implied volatility as per the VIX, just hit the highest level on record, while the VVIX itself spiked to the highest level since the August 2015 ETFlash crash.

The also confirmed something else we observed in mid-July when we showed that the price of VIX convexity had hit an all time high, when we said that the market has never trusted the VIX as little as it did then.

In any case, the surge in the VVIX/VIX ratio prompted Wright to, well, write that the "low vol regime is under threat" from recent events in North Korea.

The Goldman strategist observes that, as a result of tensions involving the US and North Korea, "markets became concerned about potential escalation, which could negatively affect what has been a broadly good macro environment."  As part of this broad repricing of vol, the VIX spiked roughly 40% on Thursday, and the VVIX, measuring the vol of vol, jumped to its highest level since August 2015.

Is this the turning point in the low-vol regime? Here Wright points to some of his previous observations, when he wrote that "vol spikes often occur after unpredictable major geopolitical events such as wars and terror attacks, or adverse economic or financial shocks." However, whether a higher volatility regime persists generally depends on recession risks and a slowing business cycle, and perhaps this time also uncertainty over central bank policies (and inflation). "As a result, the key question is whether the current spike spills into the macro or not."

For now, Goldman believes that last week's sell-off is a "risk premium move, rather than a move based on growth expectations" so no need to panic just yet. And yet, Goldman admits the market is not nearly as sanguine.

In our view, it is likely that the low volatility regime persists until the growth/rates mix turns more negative. But the ratio of the VVIX to VIX reached its highest level in history last week, suggesting that, although vol has remained relatively anchored, markets are already significantly pricing the more latent risk that the volatility regime shifts.

And while Goldman itself does not quite agree with the market's take just yet, stating that "we believe it is too early to call the end of the current low vol regime" it does remind clients that "we previously recommended 'hedges' such as 97/93 put spreads and gold strangles to protect from sudden vol spikes. We are Neutral equity over 3m and continue to believe hedges like those above make sense."