Rising Volatility Beneath Record Highs: A Fragile Market Balance

Market risk appetite surged and then abruptly reversed following the announcement of reciprocal tariffs in April, highlighting how sensitive sentiment remains to policy shocks. What began as a tactical dip-buying response quickly evolved into a broader justification for risk exposure, driven by themes such as AI and growth narratives that are now increasingly stretched.

Although markets can continue to support elevated risk-taking if fundamentals meet expectations, the assumption of sustained low volatility through 2026 appears unlikely. Over the past year, volatility spikes linked to events such as tariff tensions, the US government shutdown, and shifts in monetary policy were sharp but short-lived. Major equity indices consistently reverted to their underlying trend, limiting the longer-term impact on sentiment.

With US indices trading near record highs and sentiment indicators historically elevated, investors may assume that the steady advance will persist. This confidence is reinforced by easing pressures across key macro themes, including inflation, geopolitics, monetary policy transitions, growth risks, and fiscal concerns. However, underlying volatility tells a different story. Medium and longer-term VIX averages have risen significantly from mid-2024 lows, suggesting that the baseline level of market sensitivity is increasing.

This rising implied volatility alongside elevated asset prices creates a fragile backdrop. While short-term volatility is often triggered by events, the broader market environment determines how powerful those triggers become. With implied volatility trending higher, markets are increasingly prone to exaggerated reactions when new information emerges.

This dynamic extends beyond US equities. Strength across speculative assets such as equities and Bitcoin, alongside continued demand for gold, points to uncertainty spreading across financial markets. When volatility broadens in scope, it becomes more systemic and persistent. When sentiment eventually turns, markets will have ample justification to reprice risk.

For traders seeking to capitalize on volatility, direct exposure through VIX-based derivatives is often inefficient due to structural decay and timing constraints. A more practical approach is to use implied volatility as a signal and then focus on correlated markets. While the S&P 500 maintains a strong inverse relationship with the VIX, heavy speculation in volatility products has reduced its effectiveness in signaling deeper trend changes.

Looking beyond equities, USDJPY remains a key barometer of global risk sentiment. The yen’s historical role as a funding currency has made the pair highly sensitive to shifts in volatility. Despite narrowing yield differentials as the Bank of Japan tightens policy, carry remains attractive during periods of complacency. If volatility rises, these positions are vulnerable to unwinding. Combined with the risk of Japanese intervention to support the yen, USDJPY is a critical market to watch as volatility conditions evolve.