Wednesday, 29 May 2013
Bonds - When volatility is waking up
"Those who have compared our life to a dream were right... we were sleeping wake, and waking sleep." - Michel de Montaigne
Given the on-going speculations around "QE tapering" and looking at the recent US data, markets participants have had much lower inflation expectations in the world, leading to a clear divergence between the S&P 500 and the US 10 year breakeven, as pointed out recently by our friend Cullen Roche from pragcap.com, graph source Bloomberg:
With such a divergence, US bonds could remain relatively nervous - top chart US 10 year yield, bottom chart MOVE index (MOVE index = ML Yield curve weighted index of the normalized implied volatility on 1 month Treasury options.):
This rise in bonds volatility could trigger more volatility on other asset classes.
As we argued last week-end, the recent move in the MOVE and CVIX indices warrant caution - source Bloomberg:
MOVE index = ML Yield curve weighted index of the normalized implied volatility on 1 month Treasury options.
CVIX index = DB currency implied volatility index: 3 month implied volatility of 9 major currency pairs.
We also pointed out in our recent conversation that the huge rally in risky assets has been similar to the move we had seen in early 2012, either, we are in for a repricing of bond risk as in 2010, or we are at risk of repricing in the equities space.
As far as Japan, is concerned, we concluded our conversation "Japanese Whispers" with the following:
"Should the volatility in the Japanese space continue to trend higher, which is currently the case, we would expect credit spreads to continue to widen, particularly for Japanese financials."
Nikkei Index - 3 Month 100% Moneyness Implied Vol versus Itraxx Japan 5 year CDS since January 2010 until today - source Bloomberg:
As per 2011, the spike in volatility in Japan has been preceding the widening move in CDS spreads for the Itraxx Japan.