Garrett DeSimone, Ph.D. and Head of Quantitative Research for OptionMetrics spoke at Global EQDerivatives Las Vegas on May 23 on the impact of treasury volatility on equity returns.
DeSimone discussed how treasury uncertainty measured by implied volatility from futures options represents a standalone risk factor for equities. Treasury vol tends to lead equity volatility and is causal to equity volatility in the markets—a factor that is often overlooked, says DeSimone.
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“In the simplest sense, stock valuations are influenced by cash flows and discount rates, and equity investors should care about treasury markets looking forward,” he says.
Although the relationship is complicated, stocks that are positively correlated with treasury volatility often have low returns. This is because they act as hedges against an uncertain rate environment, according to DeSimone, who also notes the relationship has changed in the last few years.
“The recent rate hiking environment has led to a reversal of correlation between treasury vol and equity returns, especially at the industry level. For tech specifically, treasury vol is presenting a large headwind as the potential of future hikes risks choking off valuations,” says DeSimone.
Volatility in treasury markets is also tied to tensions with China, says DeSimone. If trade risks continue to loom over markets , investors will flock to safety in treasuries, which contributes to increased treasury vol.
Watch DeSimone’s interview with NASDAQ from Global EQDerivatives Las Vegas.