Shock, shock. Opposite to traditional knowledge, the bond market could also be taking its danger cues from equities. Not less than, that seems to be the case when fluctuations within the two main volatility indices are in contrast.
Fairness buyers typically look to the CBOE Volatility Index (VIX) as a gauge of concern or future uncertainty within the inventory market. In the meantime, fixed-income buyers depend on the Merrill Lynch Choice Volatility Estimate (MOVE Index) to trace expectations of future volatility within the bond market. However which market units the tone for the opposite? Does certainly one of these volatility measures lead the opposite, or are they merely reacting to distinct sources of danger inside their very own domains?
Difficult Assumptions: Proof That Equities Lead Bond
To reply that query, we examined how the VIX and MOVE indices have interacted over time, utilizing every day information going again to 2003.
Our evaluation revealed a shocking end result: whereas fluctuations within the MOVE index don’t predict actions within the VIX, modifications within the VIX do assist forecast future strikes within the MOVE index.
This flips standard knowledge. Buyers typically assume that the bond market, with its sensitivity to rate of interest expectations and macroeconomic indicators, units the tone for equities. However at the least on the subject of market-implied future uncertainty, the connection seems reversed: the bond market is taking its cues from shares.
To discover this, we checked out how the 2 indices behave collectively. Over the past 20 years, they’ve typically moved in tandem, notably in periods of macroeconomic stress, with a 30-day rolling correlation that averaged round 0.59. However correlation isn’t causation. To check for a predictive relationship, we used Granger causality evaluation, which helps decide whether or not one time sequence improves forecasts of one other. In our case, the reply was clear: the VIX leads.
Market Stress and Non permanent Bond Management
Apparently, the sample shifts in periods of elevated stress. When each the VIX and MOVE indices spike above their seventy fifth percentile ranges, indicating a high-volatility interval, we observe a reversal: the MOVE index reveals some predictive energy over the VIX. In these moments, equities seem to take cues from bonds. Whereas uncommon, this exception means that in occasions of acute uncertainty, the standard stream of data between markets can briefly reverse.
One approach to interpret these outcomes is that as a result of the MOVE index appears to take the lead in periods of maximum uncertainty, bond managers are extra attune to very large macro shifts within the economic system and seize huge sentiment shifts higher than fairness managers (i.e., after we go from constructive to destructive momentum).
Implications for Multi-Asset and Hedging Methods
These findings could have probably the most impression not for buyers that make investments solely in a single asset, however extra so for buyers which are unfold throughout varied asset courses. The outcomes spotlight that for multi-asset managers, on the subject of assessing concern out there, it could be greatest to concentrate to the bond market when huge strikes in concern or uncertainty turn into obvious. However when coping with small actions within the notion of future uncertainty, the inventory market could surprisingly be the higher measure of danger to trace.
These outcomes even have sturdy implications for buyers who should not within the fairness market or the debt market, but use them to hedge danger. If a commodities dealer is on the lookout for early indicators of huge strikes within the fairness market or bond market to get out of commodities, they could wish to shift their consideration between the VIX and the MOVE indices as regimes transfer.
These findings problem a long-standing assumption: that the bond market at all times leads. Not less than on the subject of measuring future uncertainty, equities appear to set the tone, besides, notably, in probably the most risky moments, when bonds regain their affect. It seems that, generally, the bond market is trying extra to the fairness marketplace for future assessments of danger reasonably than the opposite manner round. These outcomes advantage additional research, not simply into which market is main the opposite, however how this spillover of uncertainty travels between them.
