Do nosebleed levels on the most widely-cited measure of bond volatility presage a counter-trend rally in risk assets?
Maybe, according to one popular strategist.
“The MOVE Index is above 150 for only the 11th time in the past 35 years,” BofA’s Michael Hartnett observed, in his latest, adding that such levels “often coincide with recessions and/or default.” They also tend to precede decent returns for stocks and junk bonds over a six month horizon if you ignore the dot-com bust and the financial crisis.
Currently, the market zeitgeist is defined by recession fears. Hand-wringing over an imminent downturn in the world’s largest economy helped catalyze a sharp decline in US yields from 2022’s highs, even as Treasurys sold off in post-holiday US trading last week. Commodities are in a multi-week losing streak and market-based measures of inflation expectations have receded. It’s the latest twist in a wild year for bonds.
One could spend days delving into nuance and specifics while documenting the myriad ways in which the interplay between soaring inflation and the Fed’s belated efforts to contain it have produced anomalies aplenty in US rates. The simplest way to encapsulate the situation is just to note, as Hartnett did, that the MOVE topped 150.
If you’re so inclined, you could make lemonade out of 2022’s lemons, Hartnett said. With the bank’s pseudo-famous Bull & Bear Indicator parked at 0.0, the MOVE registering extremes and the prospect that a recession shock in the US will at least temporarily halt the rates and inflation shocks (any downturn might give the Fed pause if not compel them to actually “pause,” while consumer retrenchment and higher unemployment may help cool prices), a summer rally in risk assets is possible. The table (below) shows median returns around prior extremes on the MOVE.
Note that the dollar tends to pull back following overshoots in US bond vol. A stronger dollar, while helpful for inflation, is a bane to risk assets.
Hartnett mentioned a restart of the Nord Stream after scheduled maintenance this month. He didn’t use the word “precondition,” but needless to say, if Russia cuts off all gas flows to Germany, all bets are off.
Arguing against any kind of durable bottom for stocks (and thereby against a sustainable rally) are cumulative flows to equity funds, which aren’t indicative of capitulation. Not even a little bit. For every $100 of inflows since the beginning of 2021, just $2 has come out of stock funds. That figure for corporate credit and emerging market debt is $88 (figure on the left, below).
The figure on the right (above) shows the largest rebounds tend to follow sizable outflows. In 2022, credit has capitulated, but stocks haven’t. Or at least not from a flows perspective.
As usual — and I’m reluctant to put it that way, but I’m not sure how else to describe the unmistakably ominous tone of his missives this year — Hartnett offered a grim assessment.
“Price action [in] 2022 is very close to that of stagflationary 1974/75 both in terms of relative performance of assets and price-action of indices,” he said, adding that the “investment backdrop is also the same.” Market participants, he wrote, are coping with bear markets in bonds and equities, “oil shocks, food shocks, monetary policy instability, fiscal policy indiscipline, industrial unrest, civil unrest and war.”
Other than all of that, though, things are fine.
