One of the questions that was front and center headed into 2018 was whether diversification was going to be harder to come by in an environment where bonds, stocks and credit were the most simultaneously expensive they’ve been in damn near 100 years.

While the stock-bond return correlation has been reliably negative for some two decades, it’s becoming harder to see how that can continue given stretched valuations in equities and the fact that the narrative around rising yields is changing. For most of the post-crisis period, rising yields were seen as a barometer of the robustness of the recovery. As long as that narrative stuck, stocks could not only digest rising yields, but could theoretically rally on the excuse that rate rise was down to optimism on the growth front (everyone clap for the reflation story).

In late January, the narrative began to shift. The rapidity with which yields were rising spooked everyone – suddenly, rate rise was seen as a sign of a looming inflation shock and real yields became a function of inflation expectations as market participants assumed that as price pressures began to show up in the data, the Fed would be forced to hike more aggressively. In short, the “Goldilocks” environment appeared to be at risk as inflation pressures seemed to be setting the stage for the type of rapid tightening that could, if not carefully implemented, choke off growth.

Of course it’s the Goldilocks narrative that underpins the low vol. regime, which means as Goldilocks fades, vol. may reset higher and that raises all manner of troubling questions in a world where damn near everyone is short vol. either explicitly or implicitly.

“With the less perfect macro backdrop the market appears more responsive to each datapoint,” Goldman writes on Monday afternoon, adding that “this has resulted in the low vol regime likely having come to an end, and higher intraday vol.” That’s rather ominous given that CPI is on deck in the morning.

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