18 September 2016
Long-term yields lead the game – the short term view
A volatility spike in both US interest rates and equity : a coincidence?
With a strange Brexit-ignoring summer behind us (see our previous post Volatility – still water runs deep), the S&P500 last week broke a 43 sessions-long bull trading range during which it has been exhibiting daily variations of no more than +/-1%. It was the 2nd longest streak over the last 20 years and another demonstration of the collateral effects of the accommodative monetary policies lead by central banks around the world: enticing investors to chase returns within the riskiest asset classes and to buy on every dip with the belief that central banks will continue doing “whatever it takes” in case things go wrong.
Feeling that central bankers were less keen on strengthening - or at least maintaining - their stimulus, both fixed income and equity markets started to drift lower. As a consequence, risk aversion increased, with the VIX index jumping from 12% to the 16% - 18% range in the following days. The so-called “fear index” is just anticipating daily variations not far from +/-1% over the next month. So, no panic at this stage but something more unusual unravels beneath the surface…
… Correlations. A simple observation of their recent behavior in relation to long-term yields and volatility raises serious concern.
As illustrated by the above chart, the correlation between the VIX index and the 30 year US Treasury yield dramatically surged over the past 2 months, rising again above 50% out of the blue. Given such a high degree of correlation, then, all other things being equal, should the 30 year US Treasury yield recover to its beginning 2016 levels, the VIX index could mathematically jump to the 30s range…
This coinciding spike in both US long term interest rates and equity volatility could just be the translation of a broad repricing of equity and credit risk premia. Watch out for a confirmation of this trend in an upcoming post from our research team on based on longer term observations.