Drivers of Option-Implied Interest Rate Volatility

Option-implied volatilities of U.S. short-term interest rates have risen sharply since late 2021, reaching their highest levels in over a decade. Although these measures declined moderately since early 2023, they remain at around the 70th percentile of their historical distribution. This note links the implied volatility of short-term interest rates to macroeconomic uncertainty and highlights two fundamental drivers of short-term interest rate volatility over the past 30 years: inflation uncertainty and growth uncertainty.