Macro

Bond Calm Hints at Volatility, Tech Stocks at Risk

Bond Market's deceptive calm hints at looming volatility, with rising inflation and growth risks threatening higher rates.

By Barry Stearns

4/4, 05:51 EDT
S&P 500
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Key Takeaway

  • Bond market calm hints at upcoming volatility with potential rate hikes, impacting stocks, especially tech, due to high-duration exposure.
  • Inflation and growth risks may drive bond yields up; MOVE index likely to rise reflecting increased inflation uncertainty.
  • Stock market volatility expected to increase as bond volatility rises, with current low equity-index correlation poised for abrupt change.

Bond Market's Calm Before the Storm

The current tranquility in the bond market, characterized by a six-month downward trend in bond volatility, is misleading. Despite this calm, underlying fundamentals suggest an impending shift towards higher volatility, which could lead to increased interest rates and greater stock market volatility. This shift poses a particular threat to high-duration sectors, such as technology, which may face underperformance and potential downside risks. The MOVE index, a gauge of bond market volatility, has been steadily declining, a trend that contrasts sharply with the rising volatility seen during the SVB crisis in 2023 and the subsequent rate hikes by the Federal Reserve.

Inflation and Growth Risks Loom

Despite the focus on slowing inflation, the volatility of inflation itself tells a different story. After a period of decline, inflation volatility is on the rise again, suggesting that the bond market's current calm may soon be disrupted by higher yields. This is further complicated by the real yield curve's behavior, which has ceased flattening and notably failed to invert, indicating persistent inflation risks. Moreover, implied short-term rate volatility has rapidly returned to its long-term average, suggesting that the market may be underestimating the potential for inflation and growth to drive rates higher.

Disconnect Between Volatility and Fundamentals

The bond market is currently experiencing a disconnect between implied volatility and underlying economic risks. While implied bond volatility has been falling, realized volatility in nominal 10-year yields has been increasing. This suggests that the market is more concerned with upside growth risks, as evidenced by recent data and the better-than-expected manufacturing ISM report, than with inflation risks. However, with inflation risks on the rise, it is likely that real-yield volatility will soon increase, further fueling volatility in nominal yields.