The World's Biggest Bond Market Is More Calm Than Ever

  • Treasury-vol index has declined for eight consecutive sessions
  • Investors should prepare for higher U.S. vol vs Europe: BAML

It’s one step forward, two steps back for bond volatility.

Bank of America Merrill Lynch’s MOVE Index, a gauge of price swings in the U.S. Treasury market, fell to a record low on Monday, bucking last month’s uptrend.

Renewed expectations that the Federal Reserve will stay the course on monetary policy in the midst of a leadership transition and the unveiling of the Republican tax plan have spurred an eight-day decline in the volatility of the world’s largest bond market.

But not everyone is convinced that the calm in U.S. Treasuries will endure, including analysts at the index provider itself.

One reason: Markets are beginning to show greater sensitivity to inflation prints relative to economic-growth data, Bank of America Merrill Lynch strategists led by Carol Zhang and Sphia Salim wrote in a Tuesday note. That matters because prices could become more unstable as the distribution of components within the consumer-price-index basket has become more skewed compared to a few years ago.

Ratio of absolute daily moves in 5-year yield on inflation data vs growth data release days

Source: BofAML

In addition, the Fed leadership change and an accelerated timeline for tax cuts are bearish risks to Treasuries, the Bank of America strategists added.

Betting on an uptrend in U.S. interest-rate volatility has been a losing strategy this year as the synchronized economic upswing and abundant liquidity capped risk premiums.

Rather than buying U.S. volatility outright, investors could embark on a pair trade through short positioning in Europe, according to Zhang and Salim. They cite the European Central Bank’s enduring lower-for-longer guidance that could further contain volatility in the region.

“We are not ready to call an imminent shift higher in the volatility regime yet, but we do see key triggers in the coming quarters for U.S. rates volatility to outperform its European counterpart,” they wrote.

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