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When High Volatility Comes With Low Rates
Submitted by Helen Thomas via Blonde Money blog,
So far, volatility has moved from FX markets into equities, as Blondemoney warned in mid-September, but the bond markets had been relatively well behaved. The white line in our cross-asset vol chart is only just starting to tick up, while the equity measures veer off into panic territory:
[ZH: Updated as of the close today...]
That equity market panic is feeding into lower bond yields in a classic “flight to safety” way. This price action might feel reassuring to investors. After all, when bonds and equities were rallying at the same time, something didn’t feel right. Now they’re moving in opposite directions, there’s a sense that it makes more sense. However the comfort is likely to be short lived. We might miss the greater dangers if we’re looking at the wrong measures, as discussed in what happens when vol eats itself.
It’s generally considered that higher volatility in bond markets would accompany higher rates. Thus, if rates are falling, volatility will remain subdued. Certainly if you look at the correlation between the US 10 year yield, and the MOVE index (the measure of US Tsys 1month implied option volatilities), there’s usually a positive relationship. i.e. when yields go up, vol goes up. Here’s a chart of the correlation over the past 4 years:
But of course, the past 4 years may not be the best representative sample. As we know from the financial crisis, at times of stress, ‘unusual’ things can happen. As the CFO of Goldman Sachs said in 2009, what happened to financial markets then was a ’6 sigma event’ – it looked like something almost impossible in terms of standard deviations (or sigma for those who fell asleep during the greek bit of their statistics class). Yet it still happened. Here’s the same chart for the financial crisis period:
Now the line is downward sloping – there was indeed a negative correlation, where lower yields led to higher volatility.
Even if you don’t like statistics (and even Blondemoney was forced to write her A Level Stats project on Manchester Utd results to make it palatable), the intuition is clear. If you’re in a more stressed or panicked environment, the flight to safety is so strong that bonds are bid, their yields fall, but volatility goes up.
Now, Blondemoney is an optimist, and doesn’t for one second think we’re in a Lehman redux. In fact, once the dust has settled on the current panic, the market will realise that these kinds of corrections are normal, that volatility is back, and that that’s OK. But we’re not there yet. We’ve all been worried about a bond market blow up for some time. Even the RBA Assistant Governor Debelle warned last night with specific reference to the fixed income market that “The lower liquidity is not evident in a rising market when assets are being bought, but will quickly become apparent in a down market as investors try to exit their positions”. But what if, as Albert Edwards said, the poor liquidity manifests itself in falling yields?
As the PIMCO Eurodollars liquidation showed, the market was already short. So the position liquidation is coming in a rally, rather than a sell-off. On top of that, inflation is falling and with oil under pressure should remain low. Meanwhile the Fed hawks evidently lost the argument to the doves in September, and their hand has been strengthened by the dollar rally. So the conditions are set for higher vol to accompany the fall in rates.
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yes, it is the typical dolt's reaction when things get shaky to go from stocks to bonds, then when they get the bounce back in their step, bonds to stocks.
Perhaps, but not until the 10 yr is below 1 percent.
If I had a bigger set of balls and a lot moar money, id love to short the short end to 5 years
The short end of what? the price of the paper, or the yield? there are better bets available.
How did it get to 1% ? where is it written that the mass mind will not shift back into equities?
the VIX is making for great trading, and that was obvious when we have months, and months of really low volatility it was setting up for these huge moves.
Since 2008, and the crash, I have not seen such moves, and volume, and when VIX starts dropping again, The rally that will come will make bears feel like they are getting torn a new asshole.
Looks like the FEAR INDEX all time lows! WOW! SEE HERE==> http://bit.ly/1fMcakI
yep, and be rewarded by herd mentality. but then what?, back to stocks only to loose it back?
smart money will rotate to sidelines after a 4 sigma gainer...
Lower yields mean higher volatility as long as the FED doesn't prop equities with more QE.
C'mon Janet, 5% prime rate, let's make the tide go out on this skinny-dipping "recovery".
Assets subject to "force majeure" get discounted, and those with immunity like treasuries get bid up. 3 or 4 more Ebola transmissions in the U.S. And the demand for treasuries will drive the return on everything under 5 yrs negative.
<<<It’s generally considered that higher volatility in bond markets would accompany higher rates. >>>
Absolute nonsense. Fade Submitted by Helen Thomas via Blonde Money blog,
In fact the charts show just the opposite.
http://bigcharts.marketwatch.com/quickchart/quickchart.asp?symb=tlt&inst...
"The bond markets have been relatively well-behaved"----LOL. Well, we don't have to worry about that anymore. They're behaving like the crew in "Animal House", now.