The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

By Jon Sindreu

LONDON, July 22 (Reuters Breakingviews) - Investors today obsess over sweeping macroeconomic issues. To the pandemic, tariff wars, and the AI revolution, add renewed Strait of Hormuz tensions, which on Wednesday sent Brent crude back up to $95 a barrel. Paradoxically, prices tell the opposite story: volatility indices are down across the board despite large moves in specific companies, industries, and countries. Sooner or later, this disconnect will resolve, perhaps unpleasantly.

Recently, derivatives markets put the probability of a Federal Reserve rate hike this month at 26%, then 42%, followed by an 11% low and a rebound to 24%. Expectations see-sawed tracking Middle East developments, soft U.S. inflation figures for June and strong manufacturing data. Throughout this, the ICE BofA MOVE Index of Treasury volatility rose modestly to 78, well below its March peak of 115. Major currency volatility is similarly subdued. Beneath the surface, however, lie tectonic shifts: the Korean won, for instance, is swinging wildly.

The equity market offers the clearest example. To index-tracking investors, risk appears low based on the Cboe Volatility Index .VIX (VIX). But the average volatility of individual stocks, measured by the Cboe S&P 500 Constituent Volatility Index .VIXEQ (VIXEQ), has surged. Typically, these gauges move together. Over the past three months, they have diverged sharply, with the spread recently reaching a record 34 points.

This is possible only because diversification is yielding more benefits than almost ever before, thanks to correlations within the S&P 500 being exceptionally low: when some stocks plunge, others soar. Last week, IBM IBM.N tumbled a momentous 25% on Tuesday after a disappointing profit update, but Goldman Sachs GS.N jumped 9% on bumper investment-banking earnings.

What explains this historical anomaly? Some analysts blame the AI craze: memory chip maker Micron Technology MU.O adding $700 billion in market value since March certainly boosts single-stock volatility. Yet rapid rotation between tech and the broader market was more a 2025 feature, when leadership between the S&P 500 Index .SPX and Nasdaq changed on 15 of every 21 trading days, compared with 10 now. Furthermore, a similar volatility pattern appears in markets with little tech exposure, including the FTSE 100 Index .FTSE, Germany's DAX .GDAXI, and France's CAC 40 .FCHI.

More likely, growing numbers of index investors realise no geopolitical catastrophe has knocked the global economy off course. Yet all the while these events give stock pickers more reason to differentiate between stocks. Many quarterly earnings have been fantastic, largely because government deficits inject money into the broad economy.

Another reason: hedge funds are executing “dispersion trades” that go long the VIX and short the VIXEQ. Banks offering these so-called quantitative investment strategies offset positions by trading stocks, potentially augmenting the very low-correlation market their clients profit from. But such feedback loops can unravel suddenly.

Historically, volatility goes hand-in-hand with falling prices. When the opposite occurs, it usually signals an unsustainable speculative frenzy, as seen earlier this year with gold, or with Micron’s South Korean rivals, SK Hynix 000660.KS, SKHY.O and Samsung Electronics 005930.KS, since last month. Whether index volatility rises from here or single-asset volatility falls - or, more likely, both - investors are clearly mispricing risk.

Follow Jon Sindreu on X and LinkedIn.

CONTEXT NEWS

As of 0930 GMT on July 22, Brent crude traded at $94.90, reflecting the latest flare-up of tensions between the U.S. and Iran. On July 10, before Iran closed the Strait of Hormuz again, it was $76.01. Global stocks have brushed off the geopolitical turmoil and rose on July 22.