What Does the Return of Oil Volatility Mean for Commodities?
The intensifying conflicts in the Middle East have increased estimates for oil volatility. We examine what this means for commodity exposures.
Near-term three-month implied oil volatility levels have spiked and are now on par with levels at the start of the Israel-Hamas War in October 2023. Continued episodic volatility has the potential to alter return and volatility paths for strategic asset allocation exposures like commodities, given that some commodity benchmarks can be very energy heavy.
So how likely is it that we are entering a prolonged period of episodic oil volatility? And should you diversify to commodity exposures that are not as focused on energy?
Implied Oil Volatility in the 89th Percentile
Implied oil volatility, which measures the market’s expectations of how much oil prices will change in the near future, is trading in the 89th percentile over the past year, having increased from the summer’s 10th percentile (Figure 1). But three-month implied oil volatility is trading in the 42nd percentile and below the median.
That longer lookback includes prolonged spikes in volatility from 2022 which were driven by recessionary fears impacting oil demand forecasts, the unevenness and uncertainty in economic data during the pandemic, and the onset of the Russia-Ukraine War (Figure 2).
There’s a similar surge in risk in realized volatility. The 60-day realized volatility for spot oil has peaked above its three-year median, but remains below 2022 levels.
Prolonged Oil Volatility Unlikely
The ongoing conflict in the Middle East and the uncertainty of the US presidential election will likely exacerbate episodic oil volatility. And that could alter the return and volatility paths for commodities.
But growth remains, on balance, well-behaved and should help underpin oil demand. Notably, when volatility spiked for a prolonged time in 2022, growth was uncertain and implied US recession odds over a 12-month period reached 60%.1
Today’s global economy makes prolonged oil volatility unlikely. But keep an eye on energy-heavy commodity benchmarks during periods of episodic volatility.
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