Contrary to what the Federal Reserve thinks, low US Treasury volatility is dangerously explosive

Contrary to what the Federal Reserve thinks, low US Treasury volatility is dangerously explosive by Michael McKenna
Following the Fed meeting last week, we have seen the MOVE index falling to historic lows. Although low volatility is what the Fed is looking to achieve, we believe that it creates even higher market risk as we are approaching the US election.

I cannot say it enough: US Treasuries are the biggest mousetrap of all time. 

As we explained in an article we published last week, near-zero yields offer just a limited upside for investors while the downside remains large. On top of it, volatility in US Treasuries has sunk to the lowest level seen in history, making them even less attractive.

I am shocked to see a number of articles discussing how the US yield curve steepened during Friday’s afternoon session as the stock market was sliding. Is it worthwhile to pay attention to a one basis point movement in 30-year Treasury yields amid a selloff in the equity market? Maybe I am becoming too old for this game, but I cannot bear news channels discussing government bonds’ movements when there is none.

At the moment, the yield curve is dead. We will not see it moving on the basis of monetary policy expectations because the market has received the Fed’s message loud and clear.  What the Fed has failed to see, however, is that as the US election approaches, volatility in US Treasuries is going to resume in any case. In this context, the attempt to eradicate market volatility actually might cause even higher uncertainty.

The anxiety surrounding the US election is mounting. Everybody knows that this will be an election like no other where we’ll most likely see a significant delay of the results amid postal ballots. 

By keeping interest rates low for longer, the Fed is producing the unwanted side effect that whenever there is volatility, market reactions will be amplified. In the destabilizing case of a selloff, panicking investors will sell whatever is hot in their portfolio. At that point, the market will find out that risky assets have become riskier because of the Fed low-interest rate policies. As a matter of facts, companies have been leveraging up their balance steadily as the Fed was cutting interest rates, contributing to a vulnerable system apt to selloffs. It’s a vicious circle, which will never stops. When the Fed perceives panic, it will implement Modern Monetary Theory policies. Hence, companies start to take on more debt until volatility manifests itself and the Fed will need to act again. Only that volatility will be every time higher than before.

Topics: Bonds Government Bonds United States

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