Financial markets like calm. When stock prices rise steadily and daily swings get smaller, investors feel more comfortable. Risk reports look better, portfolios look safer, and taking on more risk becomes easier to justify. But a calm market is not necessarily a safe market.
Volatility only measures how much prices have been moving. It says little about the risks building underneath them. A long stretch of calm can even push investors to take more risk, precisely because everything looks safe. The Bank for International Settlements, a bank for central banks, has described how this works. Banks and funds set risk limits using a standard estimate of how much they could lose on a bad day. When prices are calm, that estimate shrinks, so the same limit lets them hold riskier assets and borrow more. Stability feeds the conditions for instability.
A real example is August 2024. Markets had been unusually quiet for a long time, and many investors had borrowed heavily in yen to buy higher-yielding assets elsewhere. When prices finally jolted, those investors rushed to sell at the same time. The same institution found that the violence of the move reflected, in part, the long period of risk-taking that came before it, and it estimated these trades at about 40 trillion yen, roughly $250 billion. The calm had not removed the risk, it had hidden it.
This matters even more when central banks hold interest rates down. We often talk about rates as buttons: inflation rises, so rates go up; the economy weakens, so rates come down. But an interest rate is also a price. It tells people whether to save or borrow, which projects look worth funding, and how much future income is worth today.
When rates are pushed below where they would otherwise be, people respond sensibly to the new numbers. A government bond that pays almost nothing stops looking attractive, so investors look for more return. Some buy stocks. Others buy riskier debt. Companies borrow more cheaply, asset prices rise, and the extra reward for taking risk shrinks. None of this needs irrational behavior. People are reacting to the prices in front of them. The problem is that those prices were shaped by policy.
Cheap credit makes capital look more plentiful than it is. But a lower interest rate does not create more factories, machines, workers, energy, or real savings. Changing the price of capital is not the same as creating capital. This is the core of the Austrian argument: interest rates link what people save today with what entrepreneurs invest in. When that signal is bent, investment gets bent with it.
The same blind spot shows up in quantitative finance. Banks and asset managers rely on volatility and loss estimates, and these tools are useful. I work in quantitative finance myself, so I would never argue that models are worthless. But a model can only analyze the data it is given. Imagine several years of cheap credit, plentiful liquidity, rising prices, and low volatility. A risk model fed those years will correctly say that markets have been stable. It cannot say whether the conditions behind that stability will last.
That is the difference between risk and uncertainty. Risk can be estimated: we can measure past volatility, how assets move together, and possible losses. Uncertainty is different. Tomorrow depends on decisions people have not made yet. Consumers change their minds, entrepreneurs make mistakes, governments change policy, central banks reverse course, and confident investors turn fearful. No dataset contains tomorrow’s decisions. Models are not useless, but they have limits.
And this is relevant today. The Federal Reserve’s May 2026 Financial Stability Report noted that US stock valuations remained high, with expected-earnings multiples well above their historical median, while the extra yield on corporate bonds stayed at the low end of its historical range. That is a description of conditions, not a prediction of a crisis. But markets can look both expensive and calm at the same time, and that combination should make us cautious about treating low volatility as low risk.
Here is how the cycle can run. Investors get used to cheap financing and quiet markets. Lower volatility improves their risk numbers, better numbers allow bigger positions, and rising prices build confidence. Everything looks healthy. Then conditions change. Inflation returns, rates rise, and borrowing gets more expensive. Companies that looked profitable on cheap money face much higher costs. Leveraged investors have to cut positions. Volatility comes back.
But the risk did not appear when prices started moving. Most of it was already there, just out of sight. The Fed itself separates shocks, which are hard to predict, from vulnerabilities, which can build up beforehand and make a shock worse. We may never predict the shock. We can still notice the fragility.
This is why market prices matter. A price does more than say what something costs. It carries information about scarcity, preferences, and the choices of millions of people. Interest rates do the same job. Central banks can influence them, supply liquidity, and calm markets in a panic. What they cannot do is remove uncertainty.
Trying to erase every sign of instability can create a new problem. If investors come to believe that central banks will always step in when prices fall, they may take on more leverage and more risk than they otherwise would. Markets look safer because everyone expects someone else to provide the safety. The risk has not gone away, it has changed form.
So there is nothing healthy about a market just because prices are moving slowly. Sometimes volatility is information, sometimes falling prices are information, and sometimes instability is the market revealing mistakes made while everything looked stable. Low volatility does not mean low risk. Sometimes it only means the risk has not shown itself yet.
