BIL - The Bond Market Now Looks To The Fed

Summary

• If the Fed won’t follow the bond market, maybe the bond market will follow the Fed.
• Last year’s decline in stocks was not about earnings but about rising interest rates.
• Shorting options tend to suppress volatility indexes, which is one reason why the VIX has been so well-behaved.

If the Fed won't follow the bond market, maybe the bond market will follow the Fed.

The 2-year note, the most sensitive to Fed policy, has had a huge move this month, rising from a low of 4.04% in early February to 4.72% last week before backing off a little. The same numbers for the 10-year note rose from an intraday low of 3.33% to an intraday high of 3.93%. Both are huge moves and they have been ignored by the stock market, so far, but possibly not for much longer.

Last year's decline in stocks was not about earnings but about rising interest rates. This year, we had assumed that most of the Fed's interest rate increases were behind us; but so far, the action in bonds suggests that this was an erroneous assumption. My guess is that the October high in 10-year notes of 4.34% will stand, but stranger things have happened than violating a prior major high in Treasury yields.

I don't believe the stock market is prepared for 10-year Treasury yields to again cross the 4% mark or for the 2-year note to make a higher high this cycle, but it sure looks like the Fed funds could end above 5%.

Fed fund futures are already pricing in a terminal rate - where the Fed stops hiking rates - above 5%, and the Fed looks hell-bent on going to 5.25% if the economic numbers keep surprising on the strong side.

I noted last year that stocks ignored the renewed rise in Treasury yields for about 1-2 weeks before it got going. Last week was the second week with a recurring delay, so this week could see some fireworks.

One Reason for Depressed Volatility

It is well known that most pros prefer to short options using spread strategies, as that way the decay in the options price works in their favor. Milking bid-ask spreads, the market makers' goal, as option volumes exploded, is to go from listing monthly options to listing weekly to listing three times a week and now listing daily options. "Zero days to expiration" (ODTE) options have arrived, and they are listed every day on liquid ETFs and indexes and some stocks, and they expire that same day.

Traders are typically short-term and let them expire out of the money or buy them back at a lower price.

Shorting options tend to suppress volatility indexes, which is one reason why the VIX has been so well-behaved. Still, with the last four quarterly volumes roughly double the norm in 2021, we are headed for some kind of reckoning, and a volatility spike higher than anything we have seen in 2021 or 2022.

I think we will see the VIX above 40 this year, and it may very well come this quarter or next, with Ukraine flaring up again, interest rates rising, and ODTE options volumes exploding.

All content above represents the opinion of Ivan Martchev of Navellier & Associates, Inc.

Disclosure: *Navellier may hold securities in one or more investment strategies offered to its clients.

Disclaimer: Please click here for important disclosures located in the "About" section of the Navellier & Associates profile that accompany this article.

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