Record Low Bond Volatility Heading Into Rate Hikes

The Bank of International Settlements (BIS), known as the “central bank of central banks,” has been outdoing itself lately. Not only did it discover $14 trillion in debt hidden in “footnotes,” but in its recent report titled “Strong outlook with low inflation spurs risk-taking,” “pretty much summarized (the) disinflation boom theme,” a Jefferies report noted. It all points to an economic environment never before witnessed, as low bond market volatility is a market feature heading into a rate hike cycle. But that headline of “low volatility” might not actually be the case when the skew spreads are considered.

The traditional path of bond market volatility is for it to rise as a rate hike cycle is approaching. But what is currently occurring, the BIS noted, is a taming of this corollary indicator.

The issues started in June when market participants sold bonds, sending yields sharply higher, as speeches by the ECB President Mario Draghi and the Bank of England Governor Mark Carney indicated the possibility of a broader-based tightening in major advanced economies, following the lead of the US.

But then central bankers, through dovish statements, soothed market participants with reassuring words that all was well in the world of low interest rates. Bond market Vvolatility likewise, resumed its muted path. In August, the US MOVE index, a measure of bond market volatility, touched record lows. While bond markets were basically comatose to risk, the stock market likewise was experiencing near record low volatility, which was only temporarily punched higher as the specter of global Armageddon with North Korea raised its head.

The BIS report notes the dead calm:

The overall positive market mood was disrupted by political events from mid-August onwards. However, while dominating headlines, politics did not weigh strongly on markets. Stock markets fell initially from their historical highs amid rising political risks in the United States and increased geopolitical tensions relating to North Korea. Yet the effects were short-lived. Even South Korean credit default swaps hardly budged and the Korean won scarcely moved against the dollar after North Korea fired a long-range missile over Japan and conducted its biggest ever nuclear test a few days later.

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Author: Travis Esquivel

Travis Esquivel is an engineer, passionate soccer player and full-time dad. He enjoys writing about innovation and technology from time to time.

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