10Y credit S&P 500 volatility

Revisiting The Hierarchy Of Vulnerability (Again)

The bottom line (or at least from where I'm sitting), is this...

On Monday evening, we took up the vol. spillover discussion again, once again reiterating the extent to which contagion to assets outside of equities has not transpired in any meaningful way.

Notably, the reset higher in equity volatility in 2018 has been to a certain extent a U.S.-centric phenomenon for a variety of reasons outlined in the post linked above.

The consensus seems to be that at least in the near- to medium-term, this setup is unlikely to change and while there’s considerable debate about where U.S. equities vol. will ultimately settle, there’s broad-based agreement that a return to last year’s lake placid environment is increasingly unlikely.


This is the context for a quick note from Deutsche Bank’s Aleksandar Kocic which was making the rounds among clients on Monday. In it, Kocic reiterates some of the points he made last month in his “hierarchy of vulnerability” missives and also notes the extent to which a variety of factors continue to support the U.S. long end, the recent selloff and renewed obsession with 3% on 10s notwithstanding.

The migration from the long end is finding expression in the short end (and this is something he’s tied to the Fed’s efforts to retake control of the normalization process) and also to equities which are again being roiled by the factors mentioned in the post linked here at the outset.

“While we encountered some turbulence in Early February, the markets have calmed down [and] compared to the end of October, the net effect on long tenors has been slightly lower gamma and considerably lower vega,” Kocic writes.


(Deutsche Bank)

The transmission to the front end comes courtesy of the Fed response which Kocic notes has “transformed any transient bear steepening into a gradual and protracted bear flattening” (this is the “breather” dynamic).


(Deutsche Bank)

Again, it’s the same story for the long end – the rates diffs thesis supported by the persistence of Fed hikes which in turn supports the dollar despite concerns about the ballooning deficit leads to ongoing sponsorship of the U.S. long end. “Asset managers and pension funds continue to rebalance their portfolios while credit remains relatively sheltered due to declining supply of corporates and possible substitution between credit and Treasuries,” Kocic adds.

Finally, you can see the hierarchy of vulnerability in the following chart of vol. ratios which underscores the notion that, as Kocic puts it, “rates remain beneficiaries of [the current] risk distribution [as] both portfolio rebalancing and risk-off episodes favor bonds and reinforce rates stability.” That stability itself becomes a catalyst for further stability in a self-feeding fashion:


(Deutsche Bank)

The bottom line (or at least from where I’m sitting), is that vol. remains concentrated in equities. There may be some nibbling on rates gamma here and there, but nothing significant as of yet.



1 comment on “Revisiting The Hierarchy Of Vulnerability (Again)

  1. From a psychoanalytical standpoint, annuities are making a huge comeback recently.

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