Volatility, the Overton window, and the illusion of stability

Volatility spikes. Then it fades. That has become the defining rhythm of modern markets.

A shock appears, markets wobble, volatility jumps – and then, often within days, everything settles back down. Investors have learned the playbook: fade the move, sell the spike, buy the dip. It has worked often enough to become reflexive.

But this familiar pattern masks something more interesting – and potentially more dangerous.

While volatility keeps collapsing back to low levels, the range of political and economic outcomes investors are willing to tolerate has quietly expanded. In other words, the Overton window has moved, even as markets behave as though nothing fundamental has changed.

That disconnect is worth paying attention to.

The Overton window, briefly explained

The Overton window was conceived in the 1990s by Joseph Overton to help political think tanks. It’s a concept that describes the range of ideas considered acceptable in public discourse at any given time. Policies outside the window are deemed unthinkable; those inside it are acceptable, sensible, or even inevitable.

The window is not static. It shifts as ideas once considered extreme gradually become normalised.

Markets have their own version of this process. Events that once seemed unthinkable – Brexit, sustained trade wars, political pressure on central banks, aggressive fiscal dominance – now sit comfortably inside the realm of the plausible. What once would have shocked markets now barely registers.

And yet, despite this widening of the window for the policy and geopolitical landscape, volatility remains historically low. That is the puzzle.

The volatility paradox

Volatility is meant to measure uncertainty – the dispersion of possible outcomes. It’s used in financial markets to capture how the price of a financial asset goes up and down within a specific timeframe. Viewed this way, when risks rise, volatility should rise too. But that hasn’t happened.

Even as the political and economic environment has become more unpredictable, market volatility has repeatedly collapsed back to subdued levels. Equity volatility is routinely sold. Bond market volatility remains compressed. Our chart shows the decline over the last year, whilst a chart with the x-axis stretched to include 25 years of data, would show historic lows being challenged.

There are several explanations for this.

Retail investors have learned that buying the dip works. They also have a range of new tools at their disposal. Tokenisation makes markets more accessible, there’s gamification with options, and increased use of prediction markets. Institutional investors run systematic strategies that are structurally short volatility and on top of this, central banks, despite louder political scrutiny, are still assumed to act as stabilisers.

In short, volatility has become an asset to be sold, not a signal to be heeded.

When the unthinkable becomes normal

Consider how far the Overton window has moved in recent years.

Brexit was once considered economically reckless and politically impossible – until it happened. Aggressive US protectionism was once fringe thinking – until it became policy. Public attacks on central bank independence? Previously unthinkable. Open discussion of fiscal dominance? Now routine. Large-scale geopolitical tensions? Almost background noise.

Each of these developments would once have triggered lasting market turbulence. Now they are absorbed, priced, and largely ignored.

The problem is not that markets are irrational. It is that they are pricing the centre of a much wider distribution, while largely ignoring the tails.

Why volatility looks too low

Markets are good at reacting to known risks. They are much worse at pricing unknown ones.

Investors model scenarios based on history: 1998 (LTCM), 2008 (GFC), and 2020 (COVID). But truly disruptive events don’t look like past crises. By definition, they fall outside the models.

Today’s volatility regime reflects a benign backdrop: inflation will eventually be controlled, central banks remain credible, growth will slow but not collapse, and geopolitical risk will stay contained.

These assumptions may be reasonable – but they are also widely shared. That consensus itself suppresses volatility. Ironically, the more confident markets become that risks are understood, the more vulnerable they are to shocks that don’t fit the script.

Fat tails, thin pricing

What we are seeing is not lower risk – but a fatter-tailed distribution. Extreme events – which can be both good and bad, depending on the perspective – become more probable. References to the median become less relevant.

So the range of possible outcomes has widened, yet markets continue to price the average outcome as if it were dominant. Volatility remains low not because risk has disappeared, but because it has been deferred. In practical terms the market prices the centre of the distribution, which looks calm, but the tails are getting heavier.

• Rates markets are priced for benign outcomes: inflation falling back to target, policy credibility intact, no major fiscal accident. Any challenge to central bank independence or policy coherence could reprice volatility sharply.
• Credit markets assume stable funding conditions, low default dispersion, and ongoing central bank backstops. Spreads remain tight, but compensation for tail risk is thin.
• Equity markets reflect optimism around AI-driven growth, improved productivity, and the resilience of earnings. The “buy the dip” mentality remains deeply embedded.
• Foreign exchange offers a live example. The Japanese yen has been on a downtrend based on the fundamental backdrop, which describes what’s inside the Overton window. Then came the threat of intervention and maybe the real thing.

Across asset classes, low volatility has become self-reinforcing – encouraging leverage, carry trades, and complacency.

The bigger picture

The Overton window has widened. What once shocked markets no longer does.

Volatility is low not because the world is stable, but because markets have grown comfortable with instability – so long as it looks familiar. The danger lies in what sits outside that comfort zone.

Imagine an event so disruptive it renders reading this letter – or any part of your normal routine – impossible. It is a moment where the mundane office grind is shattered so completely that you realise nothing will ever be the same again.

When the next truly unthinkable event arrives – the one that doesn’t resemble past crises – volatility will not rise gradually. It will reprice violently.

Until then, volatility may remain deceptively cheap. And that, in itself, may be the biggest risk of all.