Wednesday, June 18, 2014

As Janet Yellen talks about low risk premium in the markets, risk premium declines further

It was quite strange listening to Janet Yellen's press conference this afternoon. She clearly expressed concerns about declining volatility in the markets, saying that “volatility both actual and expected in markets is at low levels”. She proceeded to say that we have plenty of uncertainty associated with the trajectory of the Fed's monetary policy and market participants should take that into account when making their decisions. The message is: investors are not pricing in enough risk premium. She was echoing comments made by the Fed's William Dudley, who recently expressed concerns about declining volatility across multiple asset classes, saying it "makes me a little nervous".

Similarly, Janet Yellen proceeded to point out - once again - how the Fed is concerned with the lofty valuations in US corporate high yield markets. As she was talking however, implied volatility (VIX) declined sharply and high yield bonds rallied.

Intraday movements in VIX and HY bond ETF in reaction to Janet Yellen's press conference

The Fed officials continue to be surprised and even annoyed by the diminishing risk premium in the markets. By striking a rather dovish tone however, the Fed is directly creating the issues that Janet Yellen is uneasy about. The irony is that we saw risk premium decline further today - while she was speaking about these concerns.

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