The stock market is not the only part of the financial system exhibiting remarkable tranquility, US markets editor Robin Wigglesworth reports. But investors should expect more turbulence in the Treasury market.
The bond market is acting like an apathetic teenager, despite everything going on. The Federal Reserve has started the slow but seismic trimming of its balance sheet. It's expected to hike interest rates next month and will soon be under new management. At the same time, the White House is trying to push through tax cuts that would balloon the budget deficit further. And some forward looking inflation measures are starting to stir.
But bond market investors are like, whatever. The Move index, the Treasury market cousin of the more famous Vix index of equity market volatility, has plunged to new record lows this month. The gauge has sagged from 72.5 points at the start of the year to just 44 points on Wednesday. And that compares to the long-term average of almost 100 since 1988.
Of course, all financial markets have been astonishingly tranquil lately. The US equity market's 30-day volatility last month touched a five- decade low. But the placidity of the Treasury market is particularly peculiar given the fundamental and technical undertows. Low equity volatility is largely a product of the supportive global economic environment. But that should arguably spur investors to ratchet up the probability of higher interest rates.
And this isn't just a quirk of the move index. The actual realised volatility of the 10-year year Treasury yield is near its pre-crisis lows. And longer term derivatives known as swaptions show that investors think this tranquillity will last for the foreseeable future.
Now this all shows the extent to which investors have resigned themselves to interest rates being stuck in the current range for a very long time. At the start of the year, most analysts said the 10-year Treasury yield would probably come above 3% by the end of this year. Now the mean forecast is for that to first happen in early 2019. US Treasury futures even suggest that it will not happen for at least another five years.
But this does look a little bit complacent. Because if the economy weakens and the yield curve is getting closer to inverting - a classic warning sign - then Treasury yields are likely to fall from here. On the other hand, if inflation finally does materialise, then Treasury bonds look vulnerable to a sell off. Either way, betting on more turbulence in the Treasury market looks like a pretty decent bet at the moment.