Just like with markets and economies, humans go through cycles of emotion and turning points – it’s often the case that when someone hits “rock bottom” that it becomes cathartic, a self-limiting turning point. The conditions faced at rock bottom tend to sow the seeds for an eventual comeback. So in thinking about bond market volatility hitting rock bottom, it’s worth pondering whether these conditions are sowing the seeds of an eventual comeback in bond volatility…
Looking at the charts, whether it's the Merrill Lynch Option Volatility (MOVE) Index or the CBOE/CBOT 10yr US T-Note Volatility Index, bond market implied volatility has hit rock bottom, and there are tentative signs that (perhaps upon reflection and introspection!) bond market volatility is making a comeback, having in both respects turned up from record lows. Worth remembering the aphorism that low volatility does not necessarily mean low risk!
In terms of realized volatility, I've applied a similar approach to the bond market as my alternative volatility indicator for the S&P500, and it is equally informative. Taking the rolling 12-month count of basis point moves in the US 10-Year treasury bond yield exceeding +/- 5bps (and the same for 10, 15, 20 bps) shows a picture of bond market volatility at a familiar low point. I say familiar, because such low points in volatility were also reached in 1998 and 2007.
While it could be a paradigm shift in volatility, my bet would be that this is a turning point for bond volatility and the global inflation and monetary policy outlook certainly supports that.
Regardless of the indicator you look at, implied volatility in the US bond market is exceptionally low.
Using this alternative indicator of bond market realized volatility reveals a picture of bond volatility at rock bottom, and in a way that looks notably similar to the "calm before the storm" in previous episodes.
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