If you’re looking for a good news story told from a broad, societal perspective, I’m not necessarily your guy.
It’s not that I’m a pessimist, it’s just that I don’t think there’s an especially good story to tell when it comes to the socioeconomic trajectory across the developed world.
In the (far) more narrow context of markets, though, there’s usually something to like somewhere, and bearishly inclined though I may be, I never hesitate to deliver good news when it’s available.
With that in mind, Goldman expects lower front-end rates vol going forward due to a “trio of factors.” Generally speaking, the calmer rates are, the better. Last year’s fireworks, you’re reminded, were propagated through rates. The front-end of the US curve often traded like a meme stock due to extreme ambiguity around the outlook for monetary policy, which was struggling with an extraordinarily uncertain macro environment.
That’s all changing for the better, Goldman’s Praveen Korapaty said, in his latest. “Implied vol at the front end has seen some respite from very elevated levels, and we think conditions are in place for further moderation,” he wrote, citing fading tail risks from March’s banking sector turmoil and decent odds of immaculate (if gradual) disinflation through labor market normalization.
“Despite some residual uncertainty, our base case for an orderly labor market rebalancing and a gradual decline in inflation seem like an increasingly likely outcome,” he went on, suggesting falling dispersion in growth, inflation and rate forecasts support the case.
The figure above illustrates the point. Recall that it wasn’t just the level of inflation (and nominal growth) which had some macro watchers convinced we exited The Great Moderation in the 2020s, but also the associated spike in macro volatility. Indeed, the whole Great Moderation narrative was more about declining macro vol than it was about any specific level of inflation.
The point: If macro forecast dispersion is compressing, and if that accurately reflects less in the way of macro uncertainty, it should mean policy will become at least incrementally more predictable, thereby allowing front-end rates vol to recede, a welcome reprieve for weary markets.
Korapaty touched on a related point. “A slower pace of Fed tightening should lower the risk of overtightening, and narrow the distribution of policy rates around the modal case,” he said, before offering a likewise upbeat assessment of trends in market microstructure. Treasury market depth, he wrote, has improved.
