10Y bonds S&P 500 volatility

For One Bank, This Is ‘One Of The Most Striking Developments Of The Past Few Weeks’

Hint: it's the normalization of U.S. equity volatility.

Following retail sales data in the U.S. on Tuesday morning, 10Y yields surged to another new “since 2014” high, breaching 3.04% on the way to 3.0539%, the highest since 2011:


So you know, if you’re in the “stocks can’t stomach a material rise in 10Y yields” crowd, then I suppose there’s reason for concern.

If you’re worried about diversification desperation (i.e., a scenario when bonds no longer act as buffer when equities are selling off), then you can take a bit of comfort in knowing that, as Goldman observes in a note out Monday evening, “bonds have gradually shifted back to being a moderate hedge for equity based on equity/bond return correlations”:


Remember, if the stock-bond return correlation flips sustainably positive in a bond rout, it’s trouble for balanced portfolios and, perhaps more worrying, for risk parity. We saw this play out in the week prior to the blow up of the short VIX ETPs.

In the same Goldman note, the bank writes that U.S. equity vol. is starting to come in line with other asset classes and other markets. As a reminder, the early 2018 spike in volatility was to a certain extent a “made in the U.S.A.” phenomenon and, in the same vein, confined to equities. Here’s how this has evolved (from our previous coverage):

Clearly, the blowup of the short VIX ETPs in early February played a role in making the U.S. experience unique and the forced de-risking by systematic strategies (think: CTAs and risk parity) that unfolded in early February made things worse. While the wipeout of the ETPs essentially cleared the deck in terms of those products’ ability to turbocharge a volatility spike, it’s not clear that some of the strategies that were caught up in the subsequent deleveraging have rebuilt their positions.

Additionally, it looks like passive investors are contributing to elevated volatility stateside, an unsurprising development considering how manic the flows into and out of some of the more popular index funds have been this year. That same propensity for investors to pile into and out of the big ETFs seems to have contributed to the recent spike in stock correlations:


On the psychological front, there’s no question that the incessant headlines from the Trump administration are making U.S. investors nervous. Even ostensibly positive news seems to come not of its own accord, but rather in response to some previous headline that the administration thinks might have been misinterpreted or otherwise unnerved folks.

And then there’s the psychological overhang from the Mueller probe. Not having any idea what the next shoe to drop will be in the special counsel investigation is a constant thorn in the side of traders, as there’s no way to hedge it.

Oh, and don’t forget the regulatory overhang in tech, which took the baton from trade war banter late last month when it comes to giving markets a reason to be nervous.

Well, for what it’s worth, in the note cited above Goldman updates you on the slow normalization of U.S. equity vol. relative to other markets and other assets. To wit:

One of the most striking developments of the past few weeks has been the normalization of S&P 500 volatility lower. The February spike in volatility had been most pronounced and most prolonged in US equities, and while vol in other markets and regions either was more anchored or retrenched lower more quickly, US equity vol lagged. Now it has also come closer to in line with vol in other asset classes (Exhibits 1-4).


Still, U.S. equities are clearly the outlier here, which reinforces the notion that for whatever reason (and there are many), they’re on the front lines when it comes to what people are going to sell if and when the myriad geopolitical risks clouding the outlook manifest themselves in some kind of “undesirable” outcome.

Also, do note that rates vol. continues to be generally anchored. One tail risk here is that bond vol. picks up and if that happens, well, you can kiss this whole thing goodbye.





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