How The Fed Created The Ultimate Paradox: Stocks At All-Time Highs With No Liquidity And Soaring Realized Vol

For the entire duration of the record rally since the March "pandemic shutdown" lows, which has pushed the S&P to all time highs, there has been something off about the market: virtually every new all-time high in spoos took place at a level of the VIX that was also a new all time high. This is a paradox: traditionally, a rising VIX (i.e., higher implied vol and a willingness by traders to pay more for downside protection) means a growing sense of apprehension about the future, and yet that has not been the case since March, in fact quite the contrary - the higher the VIX rose, the higher the S&P moved as well, prompting many veteran traders to scratch their heads. 

As shown in the chart below, the vol-SPX spot correlation clearly shifted to a new regime in the aftermath of the Covid crash (Q2 2020 and onward).

And only recently did the S&P breakout to its latest record highs see the VIX decline, although at 21 the VIX is still far above the average level the VIX traded at when the SPX hit new record highs.

Yet while implied vol has been surprisingly high - if finally drifting lower now - realized vol has been even higher and stickier.

This is just one of the countless dislocations pointed out by traders, at least those older than 16 (who are currently generating 80%+ returns on Robinhood and outperforming hedge funds 20-to-1).

As usual the root cause can be found in two familiar culprits: the soaring balance sheet of central banks which have crushed price discovery as they now add 0.7% of global GDP in liquidity every single month.

And linked to that, the ongoing obliteration of equity liquidity, which means that even odd-lot orders can now push the market at will.

Now, thanks to SocGen strategist Sandrine Ungari, we can show the direct link between central bank market intervention, the resulting lack of market liquidity and the surprisingly high - and sticky - realized volatility. As Ungari writes, "the availability or scarcity of liquidity in the most liquid markets is becoming one of the determinants of realized volatility."

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