This chart shows why market volatility may be about to surge from its 23-year low

  • The CBOE Volatility index (VIX) closed at the lowest level since 1993 on Monday, but Bank of America Merrill Lynch found that Wall Street's fear gauge should be much higher.
  • Demand for commercial and industrial loans dipped into negative territory while overall consumer loan growth remained lackluster in the first quarter.
  • Merrill found that periods of low loans demand have been mostly associated with higher volatility, not low.

Bank lenders are getting worried about the economy, but investors seem carefree about Wall Street. That seems off to the strategists at Bank of America Merrill Lynch.

The CBOE volatility index closed Monday at the lowest level since December 1993, but BofAML found that Wall Street's fear gauge should be much higher because of its past correlation to an obscure measure of economic growth.

Demand for commercial and industrial loans, a leading indicator of growth, dipped into negative territory in the first quarter, Merrill Lynch said, citing the latest Federal Reserve Senior Loan Officer survey. Merrill found that periods of low loan demand have in the past been mostly associated with rising volatility, but that's not happening now.

The firm illustrates this relationship in the chart below:

"It thus appears that the key post-election story continues — i.e. while optimism is high everybody is in wait-and-see mode pending details on tax reform from the new administration," Hans Mikkelsen, credit strategist at Merrill, said in a note to clients Monday. "The longer this lasts the greater the risk of more weakness in hard data."

Business and consumer optimism surged after President Donald Trump's shocking election victory. The jump in optimism contributed to the U.S. stock market's leap to record highs. The S&P 500 and the Nasdaq composite closed at all-time highs on Monday.

The CBO's VIX, widely considered the best gauge of fear in the market, ended Monday's session at 9.77 and was even lower in early trading Tuesday.

Monday also marked the 10th time the VIX closed below 10, and each of the previous nine times it closed below that level were followed by negative 12-month price returns on the S&P 500 index.