Is More Volatility Coming Down the Pike?
Investors looking for greater clarity about the road ahead for equities—and a break from market volatility—probably shouldn’t hold their breath.
One big reason is that stock valuations are based largely on the value of so-called “risk-free” assets, such as short-term Treasury securities.
The issue? It is hard to know what “risk-free” rates should be right now. Options on short-term interest rates are currently implying that the yield of the 2-year U.S. Treasury note is expected to fluctuate by 10 basis points per day over the next three months, by far its highest level since the Great Financial Crisis.
For the 2-year U.S. Treasury, daily swings of 10 basis points each day would be far and away the most significant level of expected fluctuation seen at any time over the past decade—it’s averaged just 1.9 basis points per day over that time. This extreme expectation is evidence of investors’ continued uncertainty about the Federal Reserve’s next interest rate moves in the coming months.
The upshot: Given the projected volatility of one of the critical components behind equity valuations, it’s hard to see how stocks will have a smooth path to run on any time soon.
Ultimately, the “dovish pivot” that some think the Fed will implement is, in our view, massively premature and built on an understanding of how the Fed operates that is just not relevant when inflation is as high as it is today. Therefore, despite the recent rally, volatility may be with us for a while. We are maintaining defensive positioning across equities and fixed income as a result.