Global Stock Selloff Makes Bargains of Treasury HedgesNikolaj Gammeltoft and Callie Bost
Investors are embracing U.S. government bonds amid rising turmoil in the equities market, sending expectations about future volatility to a six-year low.
Implied volatility, a proxy for future swings used to price derivatives, for the iShares 20+ Year Treasury Bond ETF has dropped as much as 44 percent from a June peak. The measure reached the lowest level since October 2007 last week, according to three-month data compiled by Bloomberg on options with an exercise price near the shares. The fund has climbed 4.8 percent this year, compared with a 3.6 percent decline for the Standard & Poor’s 500 Index.
Traders are seeking safety amid growing concern about the stability of emerging-market economies and the outlook for global growth. The rally in bonds and retreat for stocks is a reversal to 2013 when the Treasury ETF, tracking U.S. debt maturing in 20 years or more, declined 16 percent while the S&P 500 advanced 30 percent to a record on Federal Reserve stimulus and improving corporate earnings.
“Investors are taking a look at the bond market, we’re starting to see that rotation,” Keith Richards, a fund manager with ValueTrend Wealth Management in Barrie, Ontario, which manages C$110 million ($99 million), said in a Jan. 23 phone interview. “They’re probably selling and taking profits on equities and buying an oversold bond class, the long bond.”
Traders piled into equity hedges last week as data signaling a possible contraction in China’s factory output, the devaluation of Argentina’s peso and declines from the Turkish lira to the South African rand shook investor confidence. Stocks continued to slump yesterday, extending the S&P 500’s loss for the past three sessions to 3.4 percent.
The Chicago Board Options Exchange Emerging Markets ETF Volatility Index rose 40 percent to 28.26 last week for the biggest increase since September 2011 as the MSCI developing-nations benchmark fell 2.3 percent, according to data compiled by Bloomberg. CBOE’s VIX, calculated using S&P 500 options expiring over the next 30 days, jumped 46 percent to 18.14 for the biggest increase since 2010 as the stock gauge slumped 2.6 percent.
The VIX fell 9.3 percent to 15.80 at the close in New York. Europe’s VStoxx Index lost 3.4 percent to 19.97.
Treasuries are headed for the biggest monthly advance since May 2012, returning 1.4 percent as of Jan. 24 after falling 1.1 percent in December, according to the Bloomberg U.S. Treasury Bond Index. The 10-year yield fell for a fourth week to end at 2.72 percent, before climbing to 2.75 percent yesterday.
Among the 10 most-owned options on the Treasury fund, six were bullish. March $110 calls had the largest open interest, according to data compiled by Bloomberg. Implied volatility for three-month contracts with an exercise price near the government-bond fund was 11.13 yesterday, a one-year low compared with U.S. shares, data compiled by Bloomberg show. The volatility measure for the security was 24 percent below that of the SPDR S&P 500 ETF Trust.
Investors are getting comfortable with the Fed’s ability to scale back monetary stimulus without causing rates to rise too fast, according to Michael Purves of Weeden & Co. The U.S. central bank, which meets today and tomorrow, decided at its December meeting to start cutting monthly bond purchases by $10 billion to $75 billion.
“The Fed is going to do what it can to make sure interest rates do not accelerate too quickly,” Purves, chief global strategist at Weeden in Greenwich, Connecticut, said on Jan. 23 via phone. “The taper that was announced in December was a kind and gentle taper -– a small amount and it came with conditions. Treasuries are not going to fall off a cliff in the near future.”
The Federal Open Market Committee will reduce asset purchases by $10 billion at each meeting to end the program this year, according to the median forecasts of economists in a Bloomberg survey.
The rebound in Treasury prices is transitory as the economy improves and stocks will continue their rally, according to Adrian Miller, director of fixed-income strategies at New York-based GMP Securities LLC. Investors are forecasting bonds to underperform stocks in 2014, he said.
“In January, the data has not been supportive of this bullish thesis” for stocks, Miller said in a Jan. 23 phone interview. “As a result, you’re seeing bonds rebound and stocks slide. In my view, it’s a temporary phenomenon until the market can receive data and evidence that can corroborate the bullish view.”
The 10-year Treasury yield, a benchmark for corporate borrowing costs, is forecast to reach 3.37 percent by the end of 2014, according to a Bloomberg News survey which gives greater weighting to more recent estimates. The yield hasn’t reached that level since April 2011. The S&P 500 will climb 5.8 percent in 2014, according to the average of 21 estimates compiled by Bloomberg on Jan. 22.
Bank of America Merrill Lynch’s MOVE Index, which measures volatility based on prices of over-the-counter options on Treasuries maturing in two to 30 years, climbed 5.4 percent to 63.51 last week.
“We’re seeing this move from stocks into bonds as people take risk off,” Mark Luschini, chief investment strategist at Janney Montgomery Scott LLC, which oversees $63 billion, said in a Jan. 23 phone interview from Philadelphia. “U.S. equities were at the intersection of full valuations and increasingly positive sentiment, and that combination has made them vulnerable to less-than-perfect news.”