Treasuries Are the Least Volatile Since the 1960sBy
Ten-year yields traded this year in tightest range since 1965
Short-dated option skews in swaps flatten, gamma tapers away
U.S. bond markets haven’t looked this dopey since the days of Beatlemania.
Ten-year Treasury yields have traded this year in the narrowest range since 1965 -- the year the group had its No. 1 hits such as “Yesterday” and “Help!” -- as the reflation euphoria set off by Donald Trump’s election lost steam and the U.S. Federal Reserve achieved its interest-rate guidance.
When comparing global 10-year bonds, it’s no surprise Japan wins hands down for having seen the tightest yield range at 16 basis points given its yield curve control policy, followed by German bunds at 46 basis points, both U.K. gilts and U.S. Treasuries at 61 and Italian debt at 75.
The short-dated skew between payers and receivers on 10-year dollar swap rates is flat, indicating limited expectations for significant moves in long-dated yields. Steeper skews would indicate payers richening relative to receivers, signaling expectations for higher rates. Short-dated skews tend to predict subsequent changes in underlying rates.
U.S. rates volatility has been driven by low dispersion of economic activity and inflation, high predictability of the Fed’s policy given its forward guidance and short-volatility strategies driven by the global hunt for yield. Central bank policy remains the single most important factor driving volatility, through the impact it has on the psychology of risk-taking and supply of assets.
- U.S. 10-year yields may tick higher in 1Q via successful tax reform, Fed’s balance-sheet unwind, ECB and BOJ injecting less liquidity as well moderating Japanese demand given the limited yield pickup; that may bode well for ATM payers vs strangles given it will unlikely be a volatility event
- Drag from higher bund yields reversing year-end squeeze with heavy DV01 EGB supply in the first two months of 2018 may also weigh; however, low neutral U.S. policy rate will limit the extent that long-term yields can rise
- Expectations of higher long-term U.S. rates, with consistent overestimation by the consensus over recent years, ignores the risk of lower terminal rate in this business cycle and longer-term structural backdrop will have to change for significantly higher yields
- NOTE: Tanvir Sandhu is an interest-rate and derivatives strategist who writes for Bloomberg. The observations he makes are his own and are not intended as investment advice