Look at the stock market this week and everything seems quiet. The S&P 500 is close to its highs, and Wall Street’s favorite fear gauge, the VIX, is sitting near 16, a level that usually means investors are relaxed.
The bond market is telling a very different story.
A widely-followed bond volatility indicator is flashing red.
Bond Volatility Is Rising as Yields Climb
The ICE BofAML MOVE Index works like a VIX for U.S. government bonds. It measures how much traders expect Treasury yields to swing over the next month.
On Monday, the index closed at 101.82. That’s its first finish above 100 since the spring.
The gauge is up 35% so far in September. Since September 2008, the MOVE Index has risen 35% or more in a single month only eight times.
Behind the jump is a fast move in yields. The 10-year Treasury yield closed August at 4.76%. By Tuesday morning, it had climbed to 5.23%.
That’s a big move in just four weeks for the world’s most important interest rate.
When yields go up, bond prices go down. The iShares 20+ Year Treasury Bond ETF (NASDAQ:TLT) holds long-dated U.S. government bonds. The fund is down 4.7% in September and 9.8% since the start of the year.
On Monday, it closed at $78.62, its lowest close since it launched in 2002.
Traders have also changed their view of the Federal Reserve. Money markets now see a 70% chance of a 25-basis-point rate hike in October. They also see a better-than-even chance of another hike in December.
Yardeni: The Bond Vigilantes Are Back
Ed Yardeni has watched bond markets for more than four decades. On Monday, he called the global rise in yields his “main worry right now.”
The obvious explanation would be inflation. Oil prices jumped after the Middle East war began in February.
However, Yardeni highlighted that investors’ own inflation expectations, which are built into bond prices, have barely moved.
His explanation starts in Tokyo.
For years, investors borrowed yen at close to zero interest and used the money to buy government bonds around the world.
Now the Bank of Japan is raising rates, so those cheap loans are no longer cheap. Investors are selling the bonds to pay them back.
“Now, we may be witnessing the Revenge of the Bond Vigilantes,” Yardeni said. That’s the old name for investors who punish governments that borrow too much by selling their debt.
The U.S. gives them plenty of material. According to Yardeni, Washington now spends $1.1 trillion a year on interest, up from $300 billion at the end of 2018.
He still sees a 70% chance that his optimistic “Roaring 2020s” scenario plays out.
Still, he admitted: “The Bond Vigilantes aren’t cooperating. That’s admittedly worrisome.”
One Number to Watch
Dennis DeBusschere, analyst at 22V Research, explains why stocks haven’t panicked yet.
Higher yields make borrowing more expensive for everyone.
According to DeBusschere, what matters is how fast that happens. The recent jump, he argues, is fast enough to slow consumer spending, and that should eventually cool the rise in yields.
He expects the 10-year yield to stay between 4.8% and 5.2%. For now, he said, recession risk hasn’t really gone up, so investors are focused on strong corporate earnings rather than the economy.
He also pointed to the line that would change that.
“Recession risk could increase materially if 10yr yields move quickly above the ~5.5% level,” DeBusschere said in a Tuesday note.
The 10-year yield is now just 27 basis points below that level.
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