Treasury vol at record low spurs call for pair trade with Europe

Bloomberg

It’s one step forward, two steps back for bond volatility.
Bank of America Merrill Lynch’s MOVE Index, a gauge of price swings in the US Treasury market, fell to a record low, bucking last month’s uptrend.
Renewed expectations that the Federal Reserve will stay the course on monetary policy in the midst of a leadership transition and the unveiling of the Republican tax plan have spurred an eight-day decline in the volatility of the world’s largest bond market.
But not everyone is convinced that the calm in US Treasuries will endure, including analysts at the index provider itself.
One reason: Markets are beginning to show greater sensitivity to inflation prints relative to economic-growth data, Bank of America Merrill Lynch strategists led by Carol Zhang and Sphia Salim wrote in a Tuesday note. That matters because prices could become more unstable as the distribution of components within the consumer-price-index basket has become more skewed compared to a few years ago.
In addition, the Fed leadership change and an accelerated timeline for tax cuts are bearish risks to Treasuries, the Bank of America strategists added.
Betting on an uptrend in US interest-rate volatility has been a losing strategy this year as the synchronised economic upswing and abundant liquidity capped risk premiums.
Rather than buying US volatility outright, investors could embark on a pair trade through short positioning in Europe, according to Zhang and Salim. They cite the European Central Bank’s enduring lower-for-longer guidance that could further contain volatility in the region.
“We are not ready to call an imminent shift higher in the volatility regime yet, but we do see key triggers in the coming quarters for US rates volatility to outperform its European counterpart,” they wrote.