Bond volatility

It rather looked as if some of the capitulation of last week provided room for risk assets to move higher on Monday. The slight easing of geopolitical tensions seems to get the credit. In another encouraging sign for investors all the ten primary sectors of the S&P 500 were higher on the day as over three-quarters of the stocks rose. 

The Vix or “fear gauge” fell sharply, again giving the impression at least in the short-term investors are feeling that the recent correction has run its course. In the corrections of the past couple of years the Vix has tended to climb above 20 before the correction is complete, as yet this has not occurred, which does make us wonder whether there may be another bout of weakness before the holiday season is over. 

US treasuries and UK gilts continue to appear well bid, as the yields on the 10-year maturities remained unchanged despite Monday’s rise in risk assets. Longer-dated bond yields will need to rise at some stage as confirmation investors are gaining confidence that the economies are on a sustainable recovery. The rise in yields needs to be a gentle one, not to impact equities in a meaningful way. In 1994 a sharp fall in bond prices was the catalyst to a sharp correction in equities. For this reason we constantly look for a rise in index volatility as a lead indicator for bond and equity markets. 

The best way to track this is the Chicago Board of Trade 10-year volatility index, as one can see from the chart below courtesy of the FT. Volatility has risen recently, but so far remains below previous highs of last year. Where there does seem to be some similarity between now and May 2013 is the divergence in the directional moving indicators, as seen at the bottom of the chart. Chartists amongst you may understand the relevance or otherwise of this as it is considered an aid to assessing price strength and direction. On that occasion the spike in bond yields led to a correction of about 6% in the S&P 500, so far the correction has been about 4% another indication that there may be a bit more to go.

5-year CBOT Volatility Index and Directional Movement Index (14-day) versus S&P 500 Index. Source FT

Posted on August 12, 2014 .