Suppressed Bond Volatility May Begin to Matter as Yields Move Higher
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Market Narrative
Treasury rates moved notably higher Friday afternoon, with the most pronounced pressure concentrated in the five-, seven-, and ten-year sectors, as the ten-year yield broke out of the trading channel it had held since mid-December. The move appeared to coincide more with renewed attention on the U.S. Treasury’s quarterly refunding process, particularly discussions about restructuring the seven-year note auction calendar, than with speculation about potential Federal Reserve leadership changes.
Seven-year yields rose by more than five basis points, compared with a three-basis-point increase in the two-year, suggesting the move was driven more by issuance considerations than front-end policy expectations.
This rate breakout occurred against a backdrop of historically compressed bond and equity volatility, with realized volatility in long-duration Treasurys near levels last seen in 2019.
If yields continue to rise and volatility expands, implied volatility across bonds—and potentially equities and credit—would likely rise as well, increasing the risk that the current period of sideways consolidation in equities gives way to more persistent choppiness.
Fully Edited Transcript by ChatGPT
Treasury rates moved higher notably on Friday afternoon. Initially, the move appeared tied to speculation that Kevin Hassett may no longer be the front runner to become Federal Reserve Chair. While that remains a possibility, the alternative candidates—Kevin Warsh and Chris Waller—are generally viewed as more hawkish, although Waller has recently advocated for rate cuts.
More importantly, around 12:05 p.m., the U.S. Treasury released information related to its quarterly seven-year note auction with reopenings. At first glance, this suggested the Treasury may be considering changes to issuance down the road, potentially increasing issuance in the seven-year sector. While this does not confirm an immediate change, it was notable. Shortly after, seven-year yields took another leg higher, with rate increases occurring across much of the curve.
Reviewing the quarterly refunding announcement materials, a questionnaire scheduled for release at 12:00 p.m. on Friday, January 16, was particularly relevant. The questionnaire sent to primary dealers listed a discussion topic for the February 2 refunding announcement: converting the seven-year note from a monthly new issue to a quarterly new issue with two reopenings, similar to the ten-year. Under that structure, new issues would be auctioned in March, June, September, and December.
This does not immediately clarify Treasury’s intentions, but it raises several possibilities. Treasury may be attempting to improve liquidity in the seven-year note, preparing markets for a longer-term shift away from front-loaded Treasury bill issuance toward longer-dated securities, or simply signaling an eventual increase in overall issuance. Given the size of federal deficits, higher issuance would not be surprising, and Treasury has previously discussed terming out the debt.
Regardless of the motivation, the technical significance lies in the ten-year yield breaking out of its trading range that had been intact since mid-December. That breakout opens the possibility for the ten-year yield to move toward 4.30–4.35. The seven-year chart also shows a clear breakout, with potential to move back toward 4.10–4.20. Similar behavior was evident in the five-year, while the thirty-year lagged, reinforcing the idea that the move was concentrated in the belly of the curve rather than driven by policy expectations. The two-year rose only three basis points, further supporting that interpretation.
This concentration suggests the primary dealer questionnaire may have served as a wake-up call that Treasury is preparing markets for future changes. More clarity is likely to emerge around the February 2 quarterly refunding announcement.
At the same time, bond market volatility has been deeply suppressed. The MOVE Index has declined substantially, reflecting low volatility not just in equities but in fixed income as well. On Friday, bond volatility rose modestly. Intraday measures such as VIX TLT, which tracks implied volatility on the TLT ETF, also increased. Realized volatility in TLT over 21 days has fallen to around 7, a level not seen since May 2019, helping explain the extremely low implied volatility readings.
If rates begin rising more consistently, realized volatility would likely increase, pulling implied volatility higher. Historically, rising bond volatility has been associated not only with higher equity volatility but also with widening high-yield credit spreads, which remain historically tight. The MOVE Index has a well-established relationship with the VIX and equity market behavior, meaning sustained increases in bond volatility could pressure stocks.
Turning to equities, the S&P 500 continues to consolidate within a narrowing range that resembles a rising wedge or parallelogram formation, with limited room remaining. Similar patterns appear in the Nasdaq 100 and the Technology Select Sector SPDR. In XLK, price action has repeatedly failed to break above or below the range, while closing prices remain within the channel, suggesting compression is nearing an endpoint.
This compression has coincided with suppressed volatility across both equity and bond markets. Friday’s rate move may mark the beginning of that compression unwinding, with implications for equities in the coming sessions.
In rates, the two-year yield—downtrending since May 2024—is approaching a break of its downtrend line. Momentum indicators such as RSI have turned higher, hinting at a possible shift. A sustained rise in the two-year would imply that markets are increasingly pricing out future rate cuts.
Fed funds futures reinforce this view. December 2026 contracts have risen steadily since mid-October, reflecting roughly 50 basis points of rate cuts being removed from pricing. Similar momentum shifts are visible in 2027 contracts, which appear to be forming an ascending triangle. Even 2028 contracts show higher lows, suggesting longer-term expectations may be drifting higher.
Finally, equity volatility indicators also signal complacency. The one-month implied correlation index fell to approximately 6.79 this week, a level rarely seen. Comparable readings occurred in January 2025 and July 2024, both of which preceded meaningful market tops and subsequent volatility. Similar conditions were observed in October before a volatile period with notable drawdowns.
Taken together, these signals suggest the current sideways, choppy environment is unlikely to resolve quickly. With rates rising, volatility compressed, and issuance questions looming ahead of the February refunding announcement, near-term market dynamics warrant close attention.
Defined Terms and Jargon by ChatGPT
Quarterly Refunding Announcement (QRA): A regular update from the U.S. Treasury detailing upcoming debt issuance plans and potential changes to auction structures.
Reopening: An auction of additional supply of an existing Treasury security rather than issuing a new one.
MOVE Index: A measure of implied volatility in the U.S. Treasury market, often referred to as the bond market’s version of the VIX.
Implied Volatility: Market-based expectations of future price fluctuations, derived from option prices.
Realized Volatility: Actual historical price movement over a defined period.
Credit Spreads: The yield difference between corporate bonds and comparable-duration Treasury securities, often used as a gauge of credit risk.
Rising Wedge / Parallelogram: A technical chart pattern indicating price compression within converging trendlines.
RSI (Relative Strength Index): A momentum indicator used to assess the speed and magnitude of price movements.
Fed Funds Futures: Derivatives contracts that reflect market expectations for future Federal Reserve policy rates.
Disclaimer
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