Economic Outlook: Low Volatility

21 JUL 2014

Charlie Himmelberg, global head of credit and mortgage strategy in Global Investment Research (GIR) at Goldman Sachs, discusses the implications of ongoing low volatility in the equity markets and the global economy with GIR senior strategist Allison Nathan.


We've gone right back to moderate levels of economic growth that meet or even exceed the low levels of the pre-crisis period… And I think that's not unrelated to the low market volatility.

- Charlie Himmelberg

Charlie Himmelberg
Global Head of Credit and Mortgage Strategy, Global Investment Research, Goldman Sachs


Charlie Himmelberg, global head of credit and mortgage strategy, Global Investment Research (GIR) at Goldman Sachs, interviewed by GIR senior strategist Allison Nathan 

Recorded July 16, 2014

Charlie, there's been a lot of focus on low volatility.  As Goldman Sachs's global head of credit strategy, how low is volatility today really? 

When most people think of volatility, they naturally go to the equity market.  And in the equity market, we're seeing volatilities that are at their post-crisis lows for sure.  And even if you look over a much longer horizon of, say, the last 30 years, you're at levels that we last saw in the pre-crisis period from '04 to '07 as well as for stretches of a number of years during the mid-'90s.  So if you think about the overall range over the last 30 years, we're definitely bouncing around the low end of that range.
What I think is -- for me at least -- equally interesting if not even more so is the fact that not just financial markets as exemplified by the equity market are at low vol levels, but also the real economy.  So if you think about the volatility of growth, the depth of recessions, the magnitude of expansions, that volatility of the real economy had fallen to such low levels in the pre-crisis period that economists had come to know it at as the Great Moderation.  And that distinguished, let's say, the period from '85 to '07 from the period before that when the volatility of the economy was quite extreme by comparison. 

I think what's interesting about the current environment is that there was a presumption in the wake of the global financial crisis that the Great Moderation was over, or that it was a big hoax to begin with.  But, in fact, we've gone right back to moderate levels of economic growth that meet or even exceed the low levels of the pre-crisis period -- so much so that I've come to call it the Greater Moderation.  And I think that's not unrelated to the low market volatility.  And it's perhaps more interesting because it's somewhat less expected. 

Many market participants and observers, and even Fed Chairman Janet Yellen herself, have voiced concerns that the current low volatility will breed complacency and excessive risk taking and ultimately contribute to asset bubbles and even financial crises.  How concerned should we be about this risk? 

I mean, I'm concerned.  I'm a credit strategist.  It's an occupational hazard; I'm supposed to worry about what can go wrong.  And I think one of the things you typically worry about at this phase of the cycle is that low volatility lulls the market and market participants into a false sense of complacency about how serious the actual risk might eventually be.  And the danger, of course, from a credit perspective is that both borrowers and lenders get comfortable letting borrowers take on greater and greater levels of leverage as that low volatility extends. 

I think in this expansion or in this cycle, there's good reason to think that it's going to be different than it has been in past cycles because regulators more than anybody understand that that sense of complacency is a risk that they need to be monitoring.  And it's a risk that they're very much on top of.

You asked about the Fed and Janet Yellen.  She and other central bankers around the world have very pointedly been highlighting this as a risk of low rates and arguing that the proper way to deal with that is not by raising rates but rather to use non-rate instruments broadly known as macro-prudential tools to push back against excess leverage.  As regulators, they have tremendous discretion over banks and lenders in general and a tremendous ability in principle to push back on leveraged growth as much as they see fit. 

So I see it as a risk intrinsically.  But in this particular credit cycle, I take the view that it's probably less of a risk than it has been in the past.  And that's partly because the global financial crisis put the risks so sharply in focus that I think everybody, both regulators and investors, are very much focused on that risk. And that means it's less likely probably to be realized. 

So the key question is:  Will the current low volatility continue? 

I think it will.  I think if you reflect on the usual narrative and what ends a period of low volatility, the usual story would be that leverage grows and grows until the imbalance unwinds itself.  And that usually is a story that ends in tears. 

I think this time around, since regulators are monitoring this situation so closely and market participants themselves are much more apprehensive about taking excess leverage, that that's at least one reason we can say with some confidence won't derail this period of low volatility. 

Of course, there's always risk in the economy and there are lots of sources of uncertainty that will arise. But I think to the extent that leverage is the culprit this time around, we can expect that that low vol will continue.