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Fear, uncertainty and doubt are way down

This chart plots the implied volatility of equity and T-bond options, and thus is a good proxy for the level of fear, uncertainty and doubt (FUD) that inhabits the market. The market has effectively breathed a huge sigh of relief this past year. Implied volatility hasn't yet returned to levels that would be consistent with tranquil economic and financial conditions, but it's coming into view.

Part of this improvement is due to the shifting winds of politics; a good portion of Obama's destructive policy agenda (e.g., cap and trade, card check) has been derailed, while others (healthcare) have received considerable push-back from members of his own party. In fact, the hard-left policy agenda he has been pushing increasing appears to be out of sync with the desires of the electorate. Back in early March the market looking with great fear and trembling at the prospects of a fiscal train wreck culminating in a sweeping expansion of government powers and awesome tax increases; the worst-case scenario which seemed likely then is much less likely now.

Part of the improvement can be chalked up to emergency measures on the part of Treasury and the Fed which helped restore confidence in the banking system and averted a debilitating deflation. This in turn provided the necessary backdrop for the economy to pursue its own process of recovery.

I view this improvement in financial conditions as one of the key economic fundamentals supporting an optimistic outlook for growth in the coming year. Markets abhor FUD and risk in general, and that explains why economies generally have great difficulty posting healthy growth when conditions are highly uncertain. The greatly reduced level of perceived risk that is evident in this chart should translate directly into improved growth conditions, since it means reduced transaction costs, lower borrowing costs, and greatly reduced systemic risk.

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