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Sharp Flattening Pricing In Higher Volatility Regime In the Long Run

GLOBAL
  • Divergence has been widening sharply in recent weeks between the MOVE index, which measures bond market volatility, and the VIX as rising inflationary pressures have led to a sharp retracement in LT bond yields (top chart).
  • While investors tend to ‘rush’ to buy the dip when equities correct, the dynamics in the bond market have been slightly different, particularly when inflation is rising.
  • US 10Y yield surged to a local high of 2.8320% yesterday (Dec 2018 highs) before starting to consolidating lower in the past two days.
  • However, price volatility in the equity market is expected to remain elevated in 2022 as equities perform poorly in stagflationary regimes (high inflation, falling economic activity).
  • In addition, the bottom chart shows that the sharp flattening of the yield curve has generally preceded high-volatility regimes in the past 30 years.
    • The bottom chart shows that the 2Y10Y yield curve has historically strongly led the VIX by 30 months.

Source: Bloomberg/MNI

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