With the emergence of the omicron variant, the market narrative has once again shifted back to COVID case counts and transmission rates. This is understandable. Recent developments have the potential to upend the prevailing optimism for a slow return to normal. That said, stocks have been rattled by more than renewed fears of the pandemic. Investors are also contending with a surge in interest rate volatility. Going forward, the direction of rate volatility will likely be the other big driver, along with earnings, of equity market performance.
But while risky assets continue to advance, assets used to hedge risk are struggling. Unlike 2020, when stocks and bonds rallied together, this year hedges have cost you. Both Treasury bonds and gold are down as investors wrestle with inflation and the prospect of less benign monetary policy. To the extent this is likely to continue, I would reiterate my preference for a long dollar rather than long Treasury hedge.
Unease in rate land
After fading last summer, rate volatility has once again surged. In recent weeks the MOVE Index, which tracks implied volatility on Treasury options, has risen by nearly 40% (see Chart 1). This is one of the reasons equities have struggled and speculative growth stocks, which tend to be hyper-sensitive to interest rates, fell more than 20% from their November peak.
US Treasury Volatility