I’m always warning about VaR shocks.
More specifically, I like to remind investors that in the event rates reprice sharply higher, the return correlation between stocks and bonds could well flip positive as equities interpret the sudden spike in yields as a risk-off event.
In short, that means stocks and bonds sell off together, leaving nowhere to hide and sending systematic strats like risk parity into turmoil and forced deleveraging.
Well, that’s the subject of this morning’s chart check. Below find a few brief excerpts and an accompanying visual from BofAML.
The next tantrum Tactical considerations aside, history offers a compelling reason to be cautious on duration after recent market moves. We look at the divergence between real rates and a combination of risk assets — equities, financial stocks, credit spreads and VIX, three months into and after the prior tantrum episodes. There is no doubt that low real rates help fuel risk assets higher, feeding this disconnect. But at some point, it becomes wide enough to trigger a real rate catch-up (Chart 2 and Chart 3).
Much more on this to come, but note the ominous bit underlined and bolded above.