Expected rate and equity volatility take differing paths
Source: Bloomberg Finance, L.P, as of March 16, 2023. MOVE Index refers to the ICE BofAML U.S. Bond Market Option Volatility Estimate (MOVE) Index. VIX refers to the Chicago Board Options Exchange (CBOE) Volatility Index (VIX).
- Within the space of one week, this year’s market narrative almost entirely reversed itself. Investors, who just weeks ago were prepared for an extended period of rising or elevated rates, now expect a rapid pivot.
- Markets today expect just one more Fed rate hike (terminal rate of approximately 4.9%) followed by a series of cuts compared to expectations earlier this month of three additional rate hikes.1 Treasury yields have followed suit, with 2- and 10-year yields falling by approximately 112 and 68 basis points, respectively, in March.1
- Data released this week complicates matters, though, challenging the perception that the Fed might soon pivot. February’s CPI report was a reminder that the disinflation process could be a long, slow one while jobs data again came in strong, confirming that the Fed has more work ahead.
- Policymakers now appear to be stuck in a difficult game of whack-a-mole as they seek to balance two very different market risks: A fragile banking system vs. persistent inflation.
- Rates markets have borne the brunt of the Fed’s challenging position as the MOVE Index, which measures expected Treasury volatility, has jumped to levels last seen during the global financial crisis.1
- Additional central bank or government action, of course, could settle market volatility. But given the range of potential volatility drivers, investors may be wise turning toward alternative sources of income and total return potential.
