If past trends are anything to go by, market volatility could rise sharply over the next two years reaching levels last seen in the 1996-2000 period, the time of the Asian Crisis, the Russian default and the LTCM. According to research done by Mecklai Financial & Commercial Services, while some part of the remarkable decline in global volatility is structural, there is also a cyclical component, and that shows volatility (the S&P 100's VXO fell from around 50% in 2002 to around 22% by mid-2003 and is around 11% today) correlates closely with the Fed funds rate with a two-year lag. Given the hike in Fed fund rates over the recent past, Mecklai makes its prediction. While Mecklai is not able to discern a pattern between a steady rise (as opposed to a spike) in volatility and US equities, the dollar has strengthened in most such instances of extreme volatility in the past. This naturally would mean a weakening rupee, as also the fact that FII inflows would probably also fall with more emerging market risk aversion. Though the relationship between the VXO and historical sensex volatility is 'unstable and breaks up easily', Mecklai finds the correlation has been positive for more than 60 per cent of the time since 1988. This is reinforced by the strong lagged correlation between the rupee and the sensex. In short, be prepared for a declining sensex.
