What if we have clarity on Treasury rate direction?

 

We have been strong believers in using volatility, whether the VIX or the MOVE index, as a strong indicator of fear and uncertainty. This is a nonlinear relationship. An increase does not necessarily mean a decline in prices, but once volatility exceeds a threshold, there will be a strong price reaction. Now, we can look at the decline in the MOVE index and infer that the term premium should decline. Since September 2004, short rates have declined by 175 bps, yet long-term yields have increased. This is not what should be expected. Lower volatility should reduce risk and lower yields. This is not happening. 

So what is the reason for the higher, longer-term yields? Well, if volatility measures uncertainty, perhaps there is no uncertainty at all, and bond investors are clear. Bond buyers believe there is greater risk in holding Treasuries, that inflation is rising, and that the safety of dollar Treasuries does not exist. In that case, volatility can be lower, and rates trend higher. Lower volatility and lower uncertainty do not mean clarity is good.