Treasuries Market Ripe for Shocks as Volatility, Yields Collapse

(Bloomberg) -- There's a whiff of complacency around the world's biggest bond market, according to strategists at Morgan Stanley and money managers at a unit of Goldman Sachs Group Inc.

Treasuries have continued to surprise in a rally that's almost wiped out the climb in benchmark yields that followed President Donald Trump's election victory and sent implied volatility crashing to the least in nearly two years. Morgan Stanley proposes investors would be well served by bets that volatility will rebound, while Goldman Sachs Asset Management is attracted to trades that benefit if long-term yields increase as inflation pressures build.

Expectations for price swings have collapsed across most asset classes this year in line with the unwind of so-called reflation trades that erupted after Trump's surprise win. Disappointing economic data, such as Friday's weaker-than-expected report on the U.S. labor market, as well as China's efforts to cut financial leverage and the U.K.'s planned exit from the European Union have undermined optimism that global growth can regain momentum. That turnaround in sentiment has gone hand in hand with the evaporation of volatility in bonds, currencies and stocks.

“With an increasingly uncertain U.S. political landscape and the Fed looking to reduce accommodation, the market feels oddly complacent,” Morgan Stanley strategists including Sam Elprince wrote in a note to clients.

The Merrill Option Volatility Estimate, or MOVE Index, has tumbled 18 points this year and reached 53.49 on May 30, a level last seen in August 2014. The gauge measures swings based on one-month options for two- to 30-year Treasuries.

Traders and investors are selling volatility because that offers them decent returns at a time when yields are low and yield curves are flat, the Morgan Stanley analysts wrote. They recommend putting on forward positions related to two-year rates as the best way to profit from a rebound in expectations for price swings in the Treasuries market.

Goldman Sachs Asset feels yields are close to bottoming out at a time when the Federal Reserve is planning to raise benchmark interest rates two to three times this year. Philip Moffitt, the unit's Asia-Pacific head of fixed income, said it would be prudent to look through last week's jobs data to an extent.

“I'd suggest that we're still going to get the Fed moving two or three times this year,” he said in an interview on Monday with Bloomberg Television. U.S. jobs numbers “were a bit of a miss, but they're still strong.”

Benchmark 10-year U.S. yields declined for the past five months, the longest stretch since 2010. They dropped as much as seven basis points to touch 2.14 percent Friday, the lowest since Nov. 10.

“You'd expect the Fed would like tighter financial conditions, and that means higher rates and/or a higher dollar,” Moffitt said.

--With assistance from Benjamin Purvis and Yvonne Man

To contact the reporter on this story: Garfield Reynolds in Sydney at greynolds1@bloomberg.net.

To contact the editors responsible for this story: Christopher Anstey at canstey@bloomberg.net, Will Davies, Ravil Shirodkar