Bond-Market Volatility Portends Trouble for Stocks (October 15, 2023)

The MOVE index may be near an inflection point that coincides with negative stock returns

By Lisa Beilfuss
October 15, 2023

Renewed bond-market volatility is likely to persist. Stock investors should beware.  

Investors have been increasingly concerned about demand for large amounts of U.S. Treasuries the government is issuing to finance its high and rising public debt. Those fears became less abstract last week after a series of disappointing auctions that was capped off by a $20 billion sale of 30-year bonds.

Primary dealers–required to buy what other bidders don’t–were left with 18% of the 30-year sale. That was the biggest share since December 2021. The high yield came in at 4.837%, the highest level since 2007. The auction was “disastrous,” says money manager Florian Kronawitter. He warns that despite recent short covering and geopolitical flight-to-safety bids, what has been a relatively orderly rise in 10- and 30-year yields is becoming disorderly. 

First, as the government sells hundreds of billions of bills, notes and bonds weekly, important buyers–foreigners, banks and the Federal Reserve–have retreated. But even the appetite for bonds from those left to absorb the supply is waning. 

Consider an anecdote Pershing Square’s Bill Ackman shared last month:  

“I bumped into the CIO of one of the world’s largest fixed-income asset managers the other night and asked him how it was going. He looked like he had had a tough day. He greeted me by saying: ‘There are just too many bonds’--a veritable tsunami of new issuance each week. I asked him what he was going to do about it. He said: ‘The only thing you can do is step away.’”

Second, inflation may remain elevated for the foreseeable future. “The long-term inflation rate is not going back to 2% no matter how many times Chairman Powell reiterates it as his target,” says Ackman, noting that the target was “arbitrarily set” after the 2008 financial crisis “in a world very different from the one we live in now.” Another 3.7% year-over-year increase in the September consumer price index underlines that point.

Ackman says 5.5% may be an appropriate yield for 30-year bonds. He cautions that yields may go even higher, though, particularly in the short term. 

Stock-market volatility is historically low compared with bond-market volatility. But stock investors may be particularly vulnerable to ongoing bond-market turmoil. Aside from the fact that the long end of the U.S. bond market functions as the backbone of global financial markets, Kronawitter points to red flags in positioning data from the Commodity Futures Trading Commission.

Large fast-money accounts are the most long in at least a year, S&P 500 positioning data from the CFTC show, a signal that the market is buying the dip instead of shorting it, says Kronawitter. While more shorts would provide fuel for a sustained move higher because they would need to be covered, he says the inverse is true when traders are buying the dip as it increases the number of potential sellers in a move lower.

It is worth noting that volatility in the bond market is still well off March 2023 highs, when Silicon Valley Bank and Signature Bank failed. Yet at 128, The MOVE index, short for the Merrill Lynch Option Volatility Estimate, is at the highest level in three months. It is also significantly above the roughly 60 level heading into the Covid-19 pandemic.

Harley Bassman, managing partner at Simplify Asset Management and known as the Convexity Maven, created the MOVE index years ago while at Merrill Lynch. He describes the index as the VIX for bonds, referring to the CBOE Volatility Index that represents expectations for 30-day stock-market volatility.

In a recent discussion with economist David Rosenberg, founder of Rosenberg Research, Bassman explained that the MOVE is a real number more than it is an actual index. You could make it into a daily number, he said, by dividing the current level by the square root of 252, or the number of trading days in a year. 

The result? “We’re going to move eight basis points a day every day on interest rates for a month,” says Bassman. “That’s a pretty fat number.”

In the decade before Covid, low inflation, interest rates pinned near zero and quantitative easing kept interest-rate volatility suppressed. But given stubborn inflation, a record fiscal deficit and lower demand for U.S. Treasuries, it will be hard for interest-rate volatility to return to pre-covid levels, strategists at Deutsche Bank say.

Jim Reid, the bank’s head of global fundamental credit strategy, notes that equities are negatively correlated with the MOVE index. Since calculations started in 1988, the average in the MOVE index is about 93. The gauge has been below 100 about 60% of the time, with average weekly stock-market returns “comfortably positive,” Reid says.

Since the Fed started hiking 19 months ago, the MOVE index has averaged around 120. Reid notes that after dipping below 100 for four days in mid-September, it popped again and has been back in the 110-140 range over the last two weeks. 

It is somewhere in the 100-150 bucket for the MOVE index when stock performance pivots from positive to negative, Reid says, with recent MOVE levels “broadly consistent with that pivot point.”

Inflation returning to target would allow the Fed to move away from tighter policy and wrap up its balance-sheet shrinkage, encouraging more Treasury buyers. In that scenario, Reid says the MOVE index could easily and sustainably fall below 100, improving the outlook for risk assets.   

The risk, however, is that inflation is more or less stuck around current levels and/or deficits dominate the agenda for a long time. That translates to a MOVE index that is higher for longer and a headwind for risk assets, says Reid. 

In other words, stock investors should enjoy relative calm while it lasts. The bond market says halcyon days may be numbered.