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The recent surge in stock volatility has captivated the financial community. Throughout the swings, however, bonds have remained unusually calm. The markets are so disconnected that when the Dow Jones Industrial Average tanked more than 400 points amid concern China would sell its hoard of more than $1.1 trillion in US Treasuries in retaliation for the Trump administration’s proposed tariffs, bonds barely budged.
If that episode couldn’t move bonds, what will? At this point, only the return of inflation will bring volatility back to the bond market, which is something fixed-income investors don’t seem to believe will happen anytime soon.
To understand just how sanguine the bond market is right now, US 10-year yields was smaller than 10 basis points for a period of at least 20 trading days. Yields have been stuck in a 10-basis point range the past 22 trading days. This is the third-longest such streak since 1981, with the longest ending at 36 trading days in December. In fact, this is the third streak of greater than 20 days in just the last year.
It’s fair to point out that in a period of record-low interest rates, one would expect smaller trading ranges in yields. However bond volatility, as measured by the Bank of America and Merrill Lynch Option Volatility Estimate Index, or MOVE, hit an all-time low this year. A 50-day moving average is shown to avoid the “noise” of daily trading.
There has been a three-month correlation between the stock market’s implied volatility as measured by the CBOE Volatility Index, or VIX, and the bond market’s volatility. The MOVE and VIX have transitioned from their tightest connection on record to nothingness in a matter of months.
We believe equity investors have become unnecessarily fearful of inflation and impending reductions in central bank support while continuing to hope for record earnings. US Treasuries, on the other hand, have entered a “put up or shut up” phase. Investors are demanding central banks prove their hawkishness and evidence of mush faster inflation before pushing yields higher.
Economic growth, however, is beginning to fade across the globe, raising doubts about the return of inflation. The synchronized global economic growth that began in October 2016 is fading. The euro zone’s long streak of significantly above-average data changes is abating. Japan, Canada and Australia are now generating below-average growth.
Evidence of waning growth has bond traders doubting the notion that inflation and wage growth will soon return. The average change in inflation breakevens has been positive since September 2017. However, the number of 10-year inflation breakevens widening is rolling-over.
At the moment, stock and bond investors are focused on different priorities. The stock market is gyrating around earnings and central bank largesse. Bond investors are refusing to push 10-year yields above the closely watched 3 percent threshold without evidence that inflation is starting to take off and bring with it a faster pace of Federal Reserve interest-rate increases. Safe assets will only become as “exciting” as riskier assets once their seemingly extinct nemesis rears its head.
—Bloomberg
Jim Bianco is the President and founder of Bianco Research, a provider of data-driven insights into the global economy and financial markets
Ben Breitholtz is a data scientist at Arbor Research & Trading