Rate Volatilities Catch Up With Equity as Riskoff Takes Hold: Analysis

Volatility climbs as markets reprice central bank policies.

Volatility in rates options market is finally moving in tandem with equities after staying relatively subdued in the beginning of this year even amid liftoff in VIX, Bloomberg strategist Tanvir Sandhu writes.

At the heart of it all is the resurfacing of U.S. recession talk and heightening of global disinflationary concerns as financial markets turbulence rises in face of China slowdown while oil prices slide.

The vol on the two-year U.S. swap tenor expiring in three months has risen to an annualized 76 basis points, the highest level in almost five years, as the market dovishly reprices the Federal Reserve’s monetary policy outlook. It was at 55 basis points at the start of 2016.

The Fed raised rates for the first time in almost a decade in December.

Overnight Indexed Swaps is currently pricing a rate marginally lower than mid Fed Funds Rate of 37.5bps this year, following developments in global economy, financial markets and central bank policies since the December hike.

Federal Reserve Chair Janet Yellen said yesterday the downturn isn’t sufficient to cause the next move to make a cut a likely possibility.

In Europe too, the vol has risen to levels not seen since September, with the ten-year swap tenor expiring in three months at an annualized 69 basis points.

U.S. Treasury market is pricing in a dire scenario but the flight-to-quality can overwhelm any sense of valuation.

Investors attempting to fade rates volatility in the payer space at elevated levels may be faced with a significant amount of stress in the system at the moment with stops running across every single asset class.

The Chicago Board Options Exchange Volatility Index, the measure of U.S. equity swings known as the VIX, is at 28, compared with a high of 32 in January.

Note: Tanvir Sandhu is a cross-asset derivatives market strategist who writes for Bloomberg. The observations he makes are his own and are not intended as investment advice.

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