Bond Volatility Fades as Central Bankers Push Back on Inflation

Interest rate volatility has been sliding as the world’s largest central banks look to damp speculation that inflation will translate into any slowdown in their bond-buying programs.

U.S. three-month 10-year implied swaption volatility -- a closely watched gauge of how much prices may move over the period -- has been steadily declining, and hit the lowest levels since early March, as officials repeat the line that inflation will be transitory.

In the U.S., “volatility is low because the Fed has crushed it,” said James Athey, investment director at Aberdeen Asset Management Plc, who likes owning volatility in five-year Treasuries and swaps. “I don’t think selling vol is attractive at all. It’s like picking up pennies in front of a steam roller.” he added.

Bond Volatility Fades as Central Bankers Push Back on Inflation

The three-month measure in the U.S. implies a breakeven range of around 30 basis point, suggesting benchmark 10-year yields may trade between 1.25% and 1.85%, versus about 1.56% currently. The same gauge for Europe has a range of 17 basis points either side of the current 10-year swap rate at 0.14%.

The drop has come despite the three-month contract now covering the potential start dates for the Jackson Hole Economic Symposium. This annual gathering of global central bankers which takes place around the last weekend of August has been a popular venue for signaling changes in central bank policies.

Jackson Hole

Large bets for a hawkish shake-up at Jackson Hole were seen earlier this month, with option positions targeting a more aggressive rate outlook for both the Federal Reserve and European Central Bank.

There are a series of factors that could inject fresh volatility into markets. Federal Open Market Committee minutes show a number of participants signaling openness to discussing tapering of bond buying at “upcoming meetings” if the economy evolves as expected. This position was echoed by Fed Vice Chair Richard Clarida on Tuesday.

Over in Europe, ECB President Christine Lagarde has been playing down the chance of a policy shift at the June meeting as accelerating vaccinations and a drop in virus cases fuel speculation policy makers could soon start discussing scaling back monetary support.

The speculation has been evident in higher European bond yields, led by those which carry the most risk, such as Italian notes, and the collapse in the spread between German bond yields and interest rate swaps. The latter is on track to this month to tighten the most in a year.

©2021 Bloomberg L.P.

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