The Yield Curve Flattens, While Volatility Creeps Back In

Volatility Creeps Back In

Investors spent most of the week waiting for the latest jobs report, which showed that the pace of hiring in August slowed. Market volatility was slightly elevated compared to recent weeks.

The yield curve has flattened over the past month, due to rising expectations of an interest rate hike by the Federal Reserve Board. The difference in yield between the 2-year Treasury note and the 10-year Treasury bill has dropped to 0.79 percentage points, versus 0.87 percentage points one month ago. While short-term bond yields have risen due to increased expectations of a Fed rate hike, long-term bond yields have remained stable or fallen due to signs that inflation is in check.

In addition, the dollar moved higher along with increased expectations of a Fed rate hike, while oil sold off for the second consecutive week. The recent volatility in oil—oil prices since April have not moved in the same direction for more than three weeks at a time—demonstrates the range-bound nature of the commodity, and may be a sign that supply and demand is in balance. Investors are now focused on an upcoming informal meeting of OPEC members, where they are expected to discuss restoring stability to the oil market.

GAIN: Active Asset Allocation

The markets have been characterized by extremely low levels of volatility over the last several weeks. For example, the S&P 500 hasn’t closed with a daily move of more than 1% (positive or negative) since July 8—the longest such period in approximately two years.

That lack of market volatility has come with a lack of clear direction and market leadership as well. For example, while emerging markets outpaced domestic markets early in August, they have since softened. We continue to closely monitor the Federal Reserve Board’s impact on interest rates and the U.S. dollar. A strengthening dollar relative to other currencies, which could occur if the Fed raises rates, may act as a headwind against several emerging market economies.

In contrast, fixed income markets have seen clearer, more stable leadership. For example, corporate debt and other credit-related assets have performed well for several weeks.   

PROTECT: Risk Assist

As we expected, some modest volatility has begun to re-enter the market. Last week, the CBOE Volatility Index (VIX)—which is sometimes referred to as the “fear index” because it measures expected future levels of volatility—stood at around 14. While that is below the index’s long-term historical average, it suggests that volatility may be creeping back in. Indeed, VIX futures remain relatively steep through October—suggesting that investors are not willing to bet that today’s low volatility environment will continue as we enter the fall, and election season.

Risk Assist strategies were relatively stable last week, without much market activity to trigger either hedging or ratchets.

SPEND: Real Spend

During the past two weeks, volatility has remained significantly lower than usual. The aggregate bond market’s volatility level has hovered around 85% of its longer-term average, while the broad equity market has sat at levels around 30% of its longer-term average. In that environment, Real Spend holdings tended to trade in tight ranges with no significant “winners” or “losers.”

We believe it is likely that these low levels will normalize as volatility begins to re-enter the market. Real Spend’s focus on providing below-average volatility should position the portfolios well by helping to reduce their risk exposure.


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