The relationship between the euro, volatility and the S&P 500 is far from stable. In light of recent developments, it may be helpful to update our analysis.
1. The implied 3-month euro volatility has increased from the 5-year lows seen in the middle of last November near 6.4% to move above 9.0% at the end of last week. It has eased a bit, which is understandable give the 32 tick range yesterday, while the US was on holiday, and that the euro is within the range set last Tues-Wed between $1.3257 and $1.3394. The 100-day moving average of 3-month euro vol is just below 7.9%. A move back below there would suggest the recent increase is not the beginning of a new trend.
2. Yet while the euro vol increased, the volatility of the S&P 500, the VIX, trended lower. It peaked at the end of last year near 23% and has collapsed to multi-year lows below 12.5%. The 100-day moving average of the VIX is near 16%.
3. These divergent trends means that the correlation between euro vol and S&P vol has weakened considerably. After peaking near 0.66 last Sept, the correlation of returns (60-day correlation conducted on the percent change of the VIX and euro vol), it has fallen below 0.24, the lowest since late 2009.
4. The correlation between the euro and the S&P 500 continues to trend lower. The Great Graphic, posted here (constructed on Bloomberg) shows the correlation between the euro and the S&P 500 going back to the beginning of 2012. The 60-day rolling correlation (on percentage change) is near 0.29. It is only the second time since March 2011 that it has been below 0.30. Recall that the correlation reached a record high in late 2011 near 0.85. The decline of the correlation between the euro and S&P 500 illustrates the breakdown of the RoRo (Risk-On/Risk-off) matrix which seemed to dominate early years of the crisis.
5. This combination of this breakdown and the firmer euro volatility, if sustained, would seem to herald the normalization of market conditions. Nevertheless, with extensive QE from the Federal Reserve and BOJ still in the pipeline, the ECB's OMT facility, and the distortions this causes to asset pricing, it is difficult place much confidence in the normalization of market relationships. Still, the lower correlation between the euro and the S&P 500 is important for fund managers.