With one central bank meeting down, but two to go, VIX and VSTOXX (Europe's VIX equivalent) have plunged to 2016 lows discounting any 'events' upsetting the complacency anytime soon. However, as Goldman's options strategists note, the medium-term skew (3M to 1Y) are at or near record highs as traders prepare for turbulence amid 'Brexit', US elections, and of course the inevitable 'Fold or No Fold' Fed decisions later in the year.

Last week, the ECB delivered a predominantly constructive policy package. Over the next three days, the BoJ and the Fed will convene too. We expect the Fed to keep the rate unchanged, but also to signal that second rate hike is likely before too long.



VIX: From “Red Zone” to “Dead Zone”



Despite some post-ECB market jitters, risky assets enjoyed a healthy rally and volatility fell sharply on both sides of the Atlantic. The VIX is at ytd lows, suggesting that the equity market is expecting no imminent rate hikes, and is pricing in the recent uptick in U.S. economic data.

S&P 500 Options remain very complacent ahead of The Fed...

The S&P 500 one-week straddle is currently pricing in a +/- 1.5% S&P move for FOMC week; corresponding to S&P 500 breakevens of 1992-2052. The SPX was below the lower breakeven of 1992 last week and last saw the higher end of the breakeven range (2052) on December 30, 2015. The 1.5% straddle price is well below the 11-year average of 1.9% back to January 2005 and a 48th percentile ranking relative to the last year.

We can use S&P 500 digital option pricing to estimate the option markets probability of a given percentage decline over the next month. S&P 500 options were recently pricing in a 3% chance for a -10% market move over the next month; that is one-third of its level on February 11 when the SPX hit its ytd low and is slightly below its median level back to 2005.



But SPX 3m-1y skew levels on the rise



While 1m SPX skew suggests lower uncertainty over the short run, 3m-1y skew has been on the rise.

Exhibit 6 shows that 3m-1y SPX skew levels are all trading near their highs relative to both 1y and 10y histories.

Longer-term hedging demand may continue to increase, as investors move away from the short-term trading mentality that obsessed the market earlier in 2016, with investors now more willing to spend for optionality which covers future rate hikes, potential “Brexit” risks (suggested by a faint bump in the VSTOXX volatility term structure around June), and US election uncertainty.