Interest Rate Volatility Remains Extremely Subdued

Summary

U.S. Treasury yields look poised to inch higher and higher under little enthusiasm or fanfare. 

U.S. Treasuries have recommenced their slow grind to higher yields after a brief respite to end January. 10-year yield’s brief flirtation with dipping below 1.0% did little to entice buyers. We have argued the lower implied volatility remains along the curve the higher yields may ultimately go over the interim. 

As we showed yesterday, the global economy is quickly on the mend with 80+% of commodities producing positive year-over-year gains and 80+% of countries producing above-trend data releases. The Federal Reserve will not combat rising yields given this back drop as long as volatility remains tame and liquidity plentiful.

However bearish breaks to higher yields like we saw in November 2020 have historically seen little follow-through. For this time to be different, we must see 10-year yields rise more than 50 basis points from its close on November 3rd, 2020, to 1.4% within the next two months.

USD swaption volatility across the curve has modestly rebounded, but from truly abysmal, record-low levels. Investors continue to take the Federal Reserve at their word by expecting little to no gyration across short-end yields.

Historically, significant events like the taper tantrum in June 2013 or pandemic in March 2020 are needed dramatically induce frantic hedging and volatility expectations.

Investors have shown no conviction over the path of long-end yields to start 2021. The ratio between swaption volatility assuming a +50 versus -50 basis points shift in 30-year rates over the next year has been stuck near 1-to1.

U.S. 10-year yields may not be rising in line with improving global growth, but they are tracking their average path following global slowdowns quite well. We mark global synchronized slowdowns as any period with less than 10% of economies producing above-trend composite leading indicator (OECD).

Just like the average reaction to slowdowns since 1960, yields are recovering from a ~140 basis slide. If history continues to prove correct, yields will enter a trading range over the months ahead.

U.S. 10-year TIPS breakevens have out-performed their past reaction to global synchronized slowdowns. Like yields, inflation expectations are expected to churn sideways over the near to medium-term.

 

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