We freely admit: Figure 1 is probably the strangest chart that you will ever see, at least in finance.
You may be wondering: did they throw blue spaghetti noodle on paper for inspiration and then write an economics article about it? Or, have they spent too much time with disciples of psychologist Timothy Leary, a proponent of experimenting with psychedelic drugs?
Figure 1: Weirdest Chart Ever
We assure you that neither is the case. The above chart represents three successive iterations of the VIX-yield curve cycle, a strange but powerful economic phenomenon that has persisted since at least the end of the 1980s and to which every fixed income and equity volatility trader should pay attention. Keep reading. We will break it down in much simpler fashion.
The cycle has four phases. As with any circular motion, where to begin is arbitrary, so we will begin at the bottom of the economic cycle and work our way to mid-stage expansion.Recession: yield curve moves from flat to steep (upward slope), equity volatility is