Long-end surprise
Whilst markets continue to endure a stalemate on the macro economy’s most poignant issues, implied volatility has continued to drift lower. In the early hours of yesterday morning, President Trump kicked the can a little further down the road with respect to tariffs on Canadian goods and markets continued to look for signs of intervention, combined or unilateral, within JPY crosses. Negotiations with Iran also seem to be at a stalemate despite optimism surrounding a deal earlier this month. Despite such uncertainties, implied and realised volatility peaked in March with the threat of the Iran war before dropping 16% in EURUSD into August.
However, could the importance of yesterday’s shock headline upend the summer-lull in volatility and trigger a repricing in staggeringly low volatility? The headline in question came from the US Treasury which announced it would double the size of its liquidity supporting buy-back operations in the secondary market. In other words, the treasury will buy back $2bn worth of bonds per operation with expiries between 10 and 30 years in order to ‘support’ the smooth functioning and price discovery of the bond market. No, not ironic, that’s really the suggested logic. The treasury has effectively put an informal cap on where it will allow long-term yields to go in a sign current pricing is politically (or as the treasury would prefer you believe, economically) intolerable.
As a result the Dollar as of this announcement is being structurally offered. By informally capping US yields, investors looking to the Dollar for returns are likely to face structurally lower returns. Lower borrowing costs can offer a lifeline to public finances and equity valuations alike but all at the expense of the Dollar. For a government that has publicly espoused a strong dollar policy, its actions of coordinated currency intervention with Japan and extraordinary treasury policies are telling a different story. Is this Mar-a-Lago take two?
Discussion and Analysis by Charles Porter
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